Quilla Update -May 2020

The virus

The table below shows the latest figures for new cases per week and the changes between the latest readings and a week and a month ago, for a number of countries.

The figures show improvements in many countries over the past week and the past month. There is still a significant number of countries with readings over 10,000 new cases per week, mainly in the EM bloc.

The US still has the highest readings, but Brazil is rapidly catching up. Mexico, Brazil, Chile, Indonesia and India have not yet seen peaks in new cases per week. Iran looks to be in the grip of a serious second wave of infections.

In other news:

  • US biotech company, Moderna, announced promising results of Phase 1 trials of a possible vaccine. Markets were initially excited about this, but quickly tempered their enthusiasm when doubts arose about the statistical significance of Moderna’s results;
  • China’s most senior medical adviser warned of a possible second wave outbreak as pockets of new cases continue to appear around the country;
  • A number of US states eased their lockdown restrictions;
  • Jerome Powell and Phil Lowe said the importance of a vaccine means the pace of economic recovery depends more on scientists than policy markers: “If we don’t get breakthroughs on the medical front, then I think it’s going to be quite a slow recovery,” (Phil Lowe).

The economics

The latest data confirm the picture that has been emerging over recent weeks:

  • US jobless claims rose another 2.4 million, bringing the total to 38.6 million;
  • Estimates of US real GDP growth are still sitting around -11% year-on-year, or -40% in quarter-on- quarter annualised terms;
  • The number of operating oil rigs fell to 60% below their mid-March levels, although the pace of decline is slowing;
  • PMIs for the UK and Europe, as well as the Philadelphia Fed Index, showed higher readings than the previous month, but still show contracting growth;
  • The US Congressional Budget Office released new projections that showed a gradual recovery in the US with the unemployment rate falling more slowly than the markets currently expect;
  • Jerome Powell reiterated policy makers’ capacity to do more, but noted that the recovery could take well into 2021;
  • The Australian Government announced that errors in the JobKeeper scheme mean outlays will be $60 billion less than previously thought; a political argument immediately erupted over what to do with these “windfall” funds, even though they do not actually exist and are only part of future planned borrowing.

China featured prominently in the news last week:

  • The authorities announced some further fiscal stimulus, but there will not be a new GDP growth target given the current difficulties;
  • Beijing has taken steps to pass its own national security laws on Hong Kong, independent of the Hong Kong Legislature. This is widely seen as the beginning of the end of whatever was left of Hong Kong’s independence and a signal that Xi Xingping has finally run out of patience with resistance from Hong Kong;
  • Tensions between the US and China continued with questions raised about the possible impact on the Phase 1 trade deal between the two nations.

The markets

Equity markets rallied in response to re-openings across the US and optimism about vaccines. Developments in China tempered, but did not derail, the enthusiasm. However, the Hong Kong equity market fell 5.6% on the 22nd. Oil rallied as production cuts started to impact supply. Higher iron ore prices helped the local equity market, as well as the A$. The global supply of iron ore has been reduced by the spread of the virus in Brazil. At the same time, markets expect China’s latest stimulus measures to provide some support or demand for iron ore.

Sources: Thomson Reuters, Bloomberg

The bottom line

Markets continue to want to look on the sunny side of things and ignore the abundant risks and caveats. They prefer to listen to the promises of politicians and biotechs about vaccines coming sooner rather than later, than to the scientists warning it will be later rather than sooner.

Equity valuations have lifted again, with the US forward P/E ratio well above its start of year levels, and its equivalent in Australia close to its February levels.

The error in the JobKeeper estimates offers a way for the Government to extend the support to the labour market beyond the September cut-off. It would be smart policy to make this happen.

The developments in China are an ominous sign of how that country may be reviewing its approach to the post-Covid world. Geo-political risks are likely to increase in coming months.

We continue tracking conditions very closely to assess the balance of forces between the data on the economies, the virus and future stimulus moves. In this environment, a continued focus on capital preservation is key. We will continue to monitor the situation very closely, and when the time comes for a more positive stance on risk assets, we will unwind some of the defensive measures we have put in place.

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