Markets continued to rally in the second quarter as inflation improved, the Fed slowed its pace of rate hikes, the banking sector stabilised, and technology-related sectors rallied. Through the first half of the year, the S&P 500 gained 16.9% with reinvested dividends, while the Nasdaq and Dow returned 32.3% and 4.9%, respectively. Interest rates were also steady after their sharp jump last year, with the 10-year treasury yield hovering around 3.8%.

Three major factors have driven this rally:

• Technology stocks made significant gains, driven largely by the enthusiasm around artificial intelligence.
• Markets were looking forward to what they thought was the end of Fed tightening.
• Continued resilient economic data has raised hopes that the Fed may successfully navigate a soft landing.

However, many risks still lie ahead. Despite surprisingly stable U.S. economic growth and a historically strong labor market, leading indicators still point to a recession. Core inflation is stubbornly above policy target, requiring further Fed tightening and reducing the likelihood of near-term rate cuts. Bond yields have already risen sharply just two weeks into the third quarter. Additionally, with broad equity valuations having once again become stretched and market breadth extremely narrow, the market is priced for perfection, leaving it vulnerable to earnings disappointments. So, while recent market gains are positive, investors should maintain a cautious perspective in the second half of the year.

By Seema Shah

Seema Shah

U.S. housing affordability worsened considerably in 2022, driven by expensive home prices and soaring mortgage rates. With the Federal Reserve remaining focused on inflation, a quick recovery from here is unlikely—yet another headwind for the U.S. economy in 2023.

U.S. housing affordability, as measured by the ratio of mortgage payments to disposable household income for a median new home, has deteriorated to levels unseen since 2006. As the majority of U.S. mortgages are fixed, most existing homeowners are not seeing their mortgage payments increase. Yet, deteriorating affordability will certainly discourage new demand.

Housing affordability is driven by mortgage rates, household income, and house prices. The deterioration since the pandemic has been so significant that, in order to revert to pre-COVID levels of affordability, it would require either:

• Mmortgage rates to fall 420 basis points, or…
• household income to rise 64%, or…
• house prices to fall 39%.

Admittedly, these factors are not independent of each other and, in reality, they can move together. As a result, it may not require such exaggerated moves in any single driver to improve affordability. Even so, a recovery is likely to be a very prolonged journey. While quantitative easing in the years following the Great Financial Crisis facilitated a relatively quick recovery in housing affordability, the Fed’s prioritization of its inflation goal today means that a return to easy monetary conditions is highly unlikely this year.

Housing market conditions are usually a leading indicator for the U.S. economy. With high mortgage rates likely to continue squeezing affordability, housing demand and activity will be under pressure, intensifying the economic risks in 2023.

By Seema Shah, Chief Global Strategist

Dan Houston

Singapore is the world’s most financially inclusive market, alongside the U.S., Nordic Europe, and Hong Kong, according to the inaugural Global Financial Inclusion Index (Index) sponsored by Principal Financial Group®. The research, conducted by the Centre for Economics and Business Research and released today, examines how well a market’s respective government, financial system, and employers provide relevant tools, services, and guidance to enable greater levels of financial inclusion.

“Financial inclusion is foundational to global economic progress. As an organization focused on helping more people gain access to financial security, we believe inclusion is an integral component of a market’s ability to prepare for and recover from adversity, grow sustainably, and build a brighter future,” said Dan Houston, chairman, president, and CEO for Principal®. “The Global Financial Inclusion Index provides a rigorous, data-driven framework to track financial inclusion on a global scale. Through this we can identify the structural gaps in financial inclusivity and take steps to address them, along with many others, to help build a more productive and protected workforce and society.”

The Index examines 42 markets and scores them across three pillars — government support, financial system support, and employer support — using datapoints across public and survey-based sources.

The government support pillar examines the degree to which governments promote and enable financial inclusion, considering data on public pension support, deposit and consumer protections, employment, education, and financial literacy levels, and online connectivity.

The financial system support pillar reviews the availability and uptake of various financial products, services, and education, considering data on access to bank accounts and credit, maturation of financial technology and use of real-time payments, and the overall effectiveness of the financial services industry in promoting confidence and small to medium sized business growth.

The employer support pillar evaluates the availability and impact of employer programs to improve employee financial wellbeing and inclusion across various dimensions such as employee pension contributions, employee insurance programs, and financial guidance

In its first year, the Index is helping to develop a benchmark for financial security and inclusion across global economies.

Key findings

• In general, developed economies tend to pool towards the higher end of the Index, and emerging and developing economies cluster at the bottom. Six of the top 10 markets for financial inclusion are European and, within this group, four are Nordic. Europe’s larger economies rank at the bottom of the table, with Italy as a particular outlier at 37th. The lower half of the ranking consists mainly of countries in Latin America, sub-Saharan Africa, and Asia. Argentina ranks last.

• Economies that provide strong support from their government and financial system tend to provide a lower level of employer support – and the reverse is also true. Developed economies typically score well for government and financial system support, whereas emerging economies generally score better for Employer support.

• When considering this research on an investment basis, the markets analysed can be broadly grouped into four categories – mature, forward-looking economies; mature, backward-looking economies; young, forward-looking economies; and reliant economies – each of which provides an indication of several of the short-, medium- and long-term risks to which economies are exposed. There are some outliers to these categories – primarily some of the largest economies including the U.S., China, and India – which do not fit neatly into a single category.

• The findings suggest financial inclusion may be a powerful indicator of next generation capital and wealth markets globally. When performance in each pillar is strong, it helps promote business growth and confidence and may lead to accelerated development of a capital market. These three pillars can provide insights into its overall economic maturity and development of a market and suggest ways to drive progress.

• Markets which rank highly for financial inclusion tend to also perform well on other societal factors such as food security, productivity, economic and social resilience, standards of living, and climate change adaption. There are strong, positive correlations between the Index rankings and the rankings of markets in several other indices which track the key factors affecting global populations today.

“The Index provides a data-driven, horizontal view for developed and emerging markets to learn from each other when it comes to fostering a financially inclusive citizenry,” said Kay Neufeld, head of forecasting and thought leadership at the Centre for Economics and Business Research. “We tracked the Index against metrics that follow some of the most significant trends facing society today – like food insecurity and climate change – and recognized a clear relationship between financial inclusion and those factors that contribute to a successful society.”

Global Financial Inclusion Index

Top 10 Scoring Markets:

1. Singapore (68.9)
2. United States (68.3)
3. Sweden (65.4)
4. Hong Kong (65.1)
5. Finland (64.7)
6. Denmark (63.9)
7. Australia (63.6)
8. Switzerland (63.4)
9. Norway (63.1)
10. The Netherlands (59.8)

Bottom 10 Scoring Markets:

33: Turkey (36.1)
34. South Africa (34.1)
35. Brazil (33.9)
36. Mexico (33.3)
37. Italy (32.8)
38. Peru (32.7)
39. Colombia (32.2)
40. Nigeria (26.9)
41. Ghana (22.2)
42. Argentina (19.2)

Read the full report.

Seema Shah

Despite signs that inflation has likely peaked in certain areas of the world, the idea that the global monetary tightening cycle might soon come to an end is misplaced. With CPI levels set to remain at uncomfortable levels for the foreseeable future, inflation mitigation remains key for investors.

Softer than expected inflation data in the United States and China has prompted hopes that the global monetary tightening cycle may soon end. This view, however, is hopelessly optimistic.

U.S. headline CPI eased from 9.1% to 8.5% in July, helped by the recent softening in energy prices. Peak inflation may be behind us, but CPI will remain uncomfortably high as sticky shelter and services inflation continue to put upward pressure on prices. It will be some time before the Fed feels sufficiently comfortable to pause rate hikes.

China’s headline CPI rose from 2.5% to 2.7% in July, lower than expected but its highest level in two years. China’s inflation issue is diminutive compared to the U.S. Even so, rising food prices imply that inflation may rise further over coming months, potentially pushing it above the People’s Bank of China’s 3% target, limiting the space for rate cuts.

Unlike the U.S., Germany’s inflation peak is still ahead. Headline CPI rose from 8.2% to 8.5% in July and the relentless rise in natural gas prices will likely push inflation into double digits later this year. Against that backdrop, even the oncoming Eurozone recession cannot stop the European Central Bank from hiking rates further.

The U.S. outlook is still one of uncomfortably high inflation, China’s inflation problem may be growing, while Europe’s inflation problem is extraordinarily pressing. The need for inflation mitigation has not disappeared

By Seema Shah, Chief Global Strategist

Damien Buchet

Principal Global Investors®, a leading asset management firm with over US$576.8 billion in assets under management, today announced the launch of its new, total return emerging market debt (EMD) Fund specifically designed to meet Australian institutional investor demand for yield-oriented solutions. The Finisterre Emerging Market Debt Total Return Fund (the Fund) will be managed by Finisterre Capital (Finisterre).

“With this new fund, we are addressing the needs of the Australian institutional marketplace that sees EMD as an attractive investment. Emerging economies have coped with the pandemic reasonably well and we remain convinced that the role of EMD in investor portfolios is set to expand in the coming years,” said Damien Buchet, Chief Investment Officer for Finisterre Capital.

The Fund is designed to deliver income and capital gains while managing liquidity and limiting drawdowns during volatile market conditions. The Fund seeks to offer institutional investors more than 90% of EMD market upside for around half its volatility and less than 50% of its downside.

Beyond the use of an innovative process of risk allocation to five complementary risk/return buckets of EMD assets across the market cycle, another key feature of the Fund is its unique approach to hedging foreign exchange risk for Australian institutional investors. The Fund hedges 100% of the hard currency (U.S. dollar) exposure while leaving active local currency exposures unhedged versus the Australian dollar. This allows local investors to benefit from the Australian dollar’s positive correlation with emerging market currencies with the added protection against volatility associated with unwanted U.S. dollar risk.

The Fund has been seeded by Vision Super. Commenting on the announcement, Vision Super Chief Investment Officer Michael Wyrsch said, “We are excited by the opportunity and are looking forward to a long and productive partnership with Principal and Finisterre.”

Based in London, Finisterre is an internal investment management group of Principal Global Investors with an unrelenting focus on delivering investment solutions using various active EMD strategies.

“Our investing philosophy is completely index agnostic, truly unconstrained, and fully adapted to the efficient management of EMD, which has evolved to become an essential part of an investor’s toolkit,” Buchet said.

“Opportunistic, yield-oriented investments, which include EMD, complement a core fixed income portfolio and are designed to add diversification that balances risk and reward in a dynamic global environment.”

The Finisterre Total Return Emerging Markets Fixed Income Strategy (the same underlying strategy used in the Fund for Australia) was awarded the 2020 Emerging Markets Debt Strategy of the Year at Pension Bridge’s 2020 Institutional Asset Management Awards, further emphasising its success.

EMD as a compelling investment in recovering global economy

Principal Global Investors Managing Director and Head of Australia Helen de Mestre said local institutional investors see EMD as a compelling investment as the asset class continues to mature and looks increasingly favourable in today’s economic environment.

“The current market dynamics are driving Australian institutional investors to include EMD as a key component of a diversified portfolio that looks to boost long-term returns and generate yield,” de Mestre said. “In developing this new EMD fund, we consulted heavily with the local institutional marketplace to understand and service their needs in this dynamic economic environment”.

“We recognise that the pandemic continues to pose investment risks and, after one of the most volatile periods on record, institutional investors remain cautious. Our view is that some of the most compelling investment opportunities in fixed income are in emerging markets. The expertise of Finisterre is critical in helping investors through the active selection of EMD investments that enhance and complement core portfolios in a risk-controlled manner,” de Mestre added.

Ultimately, investors should remain focused on fundamentals and fully invested during the election.

The most contentious Presidential election in US history?

“Polls continue to signal a decisive victory for Joe Biden, with some models predicting a double-digit percentage Biden popular vote more than twice as likely as President Trump being re-elected. This is good news for investors, not because markets like one candidate better than the other, but because markets hate uncertainty and when polls narrow, there is less confidence in the eventual election result.”

“Analysis suggests there is no statistically significant correlation between the political party in office and equity market performance – elections don’t stop prevailing economic conditions from driving markets. At the same time, the outcome of the Congressional elections, in particular the Senate will arguably matter more than who sits in the Oval office because policy changes do have lasting impacts on the economy.”

Don’t let political beliefs cloud long-term investment plans

“We know from experience that polls do not have a perfect predictive track record, but neither do market expectations. The overwhelming belief in 2016 was that a Trump victory would be negative for risk assets, yet until the pandemic Trump had presided over one of the best market performances in decades.”

“Investors should remember that the fireworks and noise surrounding the election will subside, and markets will reassert a trajectory determined by fundamentals rather than election news flow.”

“In our view, reducing long-term investment allocations because of a political view means taking a stance against the ability of the US economy to grow, and believe that an active, long-term approach remains best, even for investors worried about the election.”

What effect will the policy leanings and decisions of the new President have on markets?

“Being tough on China remains one area of bipartisan support – and a key policy focus point for both sides. Trump would inevitably remain tough on China. A Biden administration, on the other hand, might return to a more predictable foreign policy stance – but would likely take a hard stance nonetheless. It is therefore likely that the relationship between the two super powers will remain confrontational. The full market impact of this tension is difficult to quantify.”

“Big Tech has been a focal point for the U.S. Government for some time, resulting in multiple federal, state and congressional antitrust investigations which have been ramped up in recent weeks. We expect the assault on Big Tech to continue regardless of who wins, but at the same time believe that action in the form of legislation is likely to be a process measured in years rather than months.”

“Markets have become increasingly preoccupied by the outlook for additional fiscal stimulus – an area where the two candidates differ significantly. A Democratic sweep would likely result in a positive fiscal stimulus package in coming years, whereas a second Trump administration would not see major changes in tax or spending policies, in other words, reduced fiscal stimulus.”

Implications for investors

“A widening of the gap between the two candidates is positive for markets because it means a prolonged spell of political uncertainty is less likely. At the same time, pre-election polls are by no means perfect predictors of outcome so adjusting portfolio allocations to position for the candidate most likely to win is a dangerous strategy.”

“Regardless of the outcome of the election, markets will remain buoyed by easy financial conditions, accommodative monetary policy and ample liquidity, factors which have already driven them to record highs despite the disastrous effects of the pandemic.”

“Ultimately, investors should remain focused on fundamentals and fully invested during the election. The priority should be diversification and active positioning for a slow and protracted economic recovery backed by central bank liquidity.”

By Seema Shah, Chief Strategist

“We are pleased to receive the EM Debt Strategy of the Year award from Pension Bridge,” said Damien Buchet, chief investment officer and portfolio manager for Finisterre Capital, the PGI investment team that manages the award-winning strategy. “The investment process applied to this strategy has been historically effective in generating benchmark-beating, total returns by investing across the full spectrum of the EMD universe^[1], even during this current period of increased volatility across global markets.”

The Pension Bridge Institutional Asset Management Awards recognize and reward the institutional asset management industry for performance and excellence across various strategies. Using a quantitative and qualitative methodology, the judging was done in two stages. The first used purely quantitative elements to derive leader boards from the entries to populate the shortlists for each category. In the second stage, a panel of independent and impartial judges ensured the data was correct and used their knowledge and the qualitative elements of the entry process to decide the winners by category. All data used for the awards was through June 2020.

———

[1] The Finisterre Total Return strategy has outperformed its benchmark (JP Morgan EM Equal Weight Index) as of each calendar year end, in six of the past seven years. Past performance is no guarantee of future results. JP Morgan EM Equal Weight Index (JEMBAGTR Index): 33.3% Corporate Emerging Market Bond Index Broad Diversification (CEMBI BD), 33.3% Emerging Markets Bond Global Diversification Index (EMBIGD), and 33.3% Government Bond-Emerging Market-Global Diversification Index (GBI EMGD)

]]> Principal Global Investors and its Finisterre Emerging Market Debt Total Return Strategy has been awarded the Emerging Markets Debt Strategy of the Year by Pension Bridge. The honour was announced on September 24 during a virtual ceremony to celebrate recipients of Pension Bridge’s 2020 Institutional Asset Management Awards.

“We are pleased to receive the EM Debt Strategy of the Year award from Pension Bridge,” said Damien Buchet, chief investment officer and portfolio manager for Finisterre Capital, the PGI investment team that manages the award-winning strategy. “The investment process applied to this strategy has been historically effective in generating benchmark-beating, total returns by investing across the full spectrum of the EMD universe^[1], even during this current period of increased volatility across global markets.”

The Pension Bridge Institutional Asset Management Awards recognize and reward the institutional asset management industry for performance and excellence across various strategies. Using a quantitative and qualitative methodology, the judging was done in two stages. The first used purely quantitative elements to derive leader boards from the entries to populate the shortlists for each category. In the second stage, a panel of independent and impartial judges ensured the data was correct and used their knowledge and the qualitative elements of the entry process to decide the winners by category. All data used for the awards was through June 2020.

———

[1] The Finisterre Total Return strategy has outperformed its benchmark (JP Morgan EM Equal Weight Index) as of each calendar year end, in six of the past seven years. Past performance is no guarantee of future results. JP Morgan EM Equal Weight Index (JEMBAGTR Index): 33.3% Corporate Emerging Market Bond Index Broad Diversification (CEMBI BD), 33.3% Emerging Markets Bond Global Diversification Index (EMBIGD), and 33.3% Government Bond-Emerging Market-Global Diversification Index (GBI EMGD)

The post Principal wins Emerging Markets Debt Strategy of the Year Award appeared first on AdviserVoice.

Seema Shah

Europe reaches tipping point

Tensions between the US and China are heating up and the European Union is facing increasing pressure to choose a side in the wake of COVID-19. That’s the view of Principal Global Investors Chief Strategist Seema Shah.

“China is increasingly considered a strategic rival to the West. Since China was accepted as a full member of the World Trade Organization (WTO) in 2001, its share of world GDP has jumped from 8% to 19%. Meanwhile, Europe’s portion has fallen from 35% to 16%,” said Ms Shah.

“On one hand, Europe’s relationship with China has profound strategic and economic significance so the EU is understandably hesitant to endanger it. On the other, European leadership recently voiced its disapproval regarding China’s market access and intellectual property theft,” she said.

China remains resilient despite global shift away

Understandably, investors may be worried about China’s evolving diplomatic implications and the deliberate global shift away from China. However, Ms Shah pointed out that both China and Emerging Asia appear to be more resilient than external observers may presume:

“While reciprocal trade tariffs with the U.S. did weigh on China’s economic growth last year—as could similar restrictions with Europe—the impact today may not be as significant as it would have been several years ago. That’s because the Chinese story is no longer about exports.

“Today, about 90% of China’s manufactured goods are consumed domestically. The country’s ratio of exports to overall GDP is lower than many major advanced economies, including Germany, France, and the U.K.—a fact that analysts often seem to overlook.

“China is also funding its own growth. Local investment is driving increased manufacturing capacity, rather than foreign corporations seeking to bolt cheap Chinese labour onto a global supply chain.

“Although additional tariffs could put pressure on the Chinese economy, domestic consumption indicates that China has become less dependent on global trade to sustain strong economic growth,” said Ms Shah.

The rest of Asia hasn’t been standing still

Looking beyond China, Ms Shah said that growth of many developed economies had been parallel to, rather than a result of, China’s growth.

“It’s evident that China isn’t the whole story for Asia. The region has many diverse economies with favourable tailwinds generated by their own rising middle classes, strong political systems, and increasingly sophisticated policymaking tools. Plus, valuations in many of these markets remain attractive, said Ms Shah.

South Korean tech companies, financial services in Asia ex-China and evolving economies in less-developed markets like Vietnam and Thailand were highlighted by Ms Shah as growth markets.

Political interference in capital markets could prove problematic for investors

However, Ms Shah warned of signals of a geopolitical scenario that could fundamentally lessen EM Asia’s investment appeal.

“In the U.S., Congress and the SEC are currently working on guidance that would; force Chinese firms to delist from U.S. stock markets if they don’t comply with U.S. auditing procedures; consider mutual funds that hold Chinese stocks to be failing their fiduciary responsibility; and encourage equity indices to reduce exposure to Chinese holdings because of their lack of financial transparency.

“The clear intention is to convince investors to reduce their investments in Chinese securities. With more than 200 Chinese companies listed in the U.S., representing more than $1 trillion of market capitalisation, political action to limit Chinese access to foreign capital would have significant consequences—not only weakening Chinese investment prospects, but also disrupting EM Asia markets,” she said.

Investors may need to navigate increasingly fraught geopolitical relationships

In conclusion, Ms Shah said there are numerous reasons for investors to maintain strategic exposure to Asia ex-China economies, but also warned of the risks.

“The geopolitical environment carries some material risks. The shifting U.S. political climate may increase the likelihood of governmental interference in capital markets. If it does, investors will need to factor that into their assessment of Chinese stocks and, by inference, emerging markets Asian assets.

“It will be important to keep a close eye on the rhetoric emerging from not just the U.S. and China, but also from the EU, as it works out how to navigate an increasingly fractured relationship,” said Ms Shah.

By Seema Shah

Bob Baur

Recovery from the pandemic recession is in progress around the world. It’s well underway in China and parts of Southeast Asia and getting a good start in the Eurozone and United States, according to Principal Global Investors Chief Global Economist Dr Bob Baur.

According to Dr Baur, the fast, sharp economic recoil from the pandemic plunge is likely over, although several countries are continuing to experience high or fast rising daily cases, especially India, much of Latin America, Indonesia and the Philippines.

US rebound dampened

The US economy had advanced in May and June, following the record collapse in March and April. However, concerns about new cases have slowed this recovery.

“We’d been expecting a V-shaped bounce that would last perhaps two to four months as U.S. businesses reopened and people started back to work. But widespread concern about the pickup in daily new U.S. COVID-19 cases since late June dampened the rebound’s vigour, likely limiting the V to two months.  The good news is that daily new U.S. COVID-19 cases may have peaked July 23 as the seven-day moving average has been falling since then, down to 61,964 on August 1. If that does prove to be the peak, the U.S. recovery will likely stay on track but at a more muted pace than in May and June,” said Dr Baur.

Dr Baur cautioned that a full recovery from the recession may be “challenging and lengthy”. “Millions of workers are still on furlough or permanent layoff. Many small businesses won’t reopen, especially in leisure and hospitality, with even large chains facing huge losses. The COVID-19 virus is proving resilient and lasting and may require major changes as we learn to live with it. We’re optimistic that the revival from the cavernous losses of March and April will last through 2021, but it will likely be at a more measured pace than the bounce since early May. As a result, the U.S. economy may not exceed its prior peaks in either GDP or employment until sometime in 2022,” he said.

Dynamic revival in China

Dr Baur said that industrial output had returned to the prior year’s level in June, and industrial profits showed a second month of growth at 11.5% over the prior year. Official purchasing manager indices (PMI) from the National Bureau of Statistics for manufacturing edged up to 51.1 in July up from a February plunge to 35.7, the worst on record. The non-manufacturing PMI slid 0.2 to a still-strong 54.2, which put the composite PMI at 54.1, the second best since mid-2018.

Real estate and stocks also performed well with construction PMI a robust 60.5 and year-to-date property investment up 1.9% from the same period last year. Chinese stock indices were world leaders in July with the Shenzhen Composite Index up a healthy 14.2%.

“Households in China stay more restrained, likely from a lingering fear of COVID-19 activity. China is experiencing a mild flareup of new cases in the last few days that may keep consumer spending from normalizing for a while. June retail sales were still 1.3% below June 2019. Vehicle sales, though, have been very strong. China was the first economy to exit the pandemic recession and its revival has been dynamic. We expect it to continue,” said Dr Baur.

Recovery in greater Europe is underway

The Eurozone composite PMI, at 54.8 in July was the best since mid-2018. Eurozone consumer sentiment is still low but rising. After a nearly incomprehensible 40.3% annualised plunge in second quarter Eurozone GDP, Dr Baur expected the upsurge in the third quarter to reach well into double digits.

“Several things are helping in the Eurozone. New cases of COVID-19 are staying low and the end of the lockdown seems to have gone fairly smoothly. The robust rebound in China has given Eurozone businesses a lift in confidence given the area’s healthy exports to China. Further, wage subsidization plans have kept unemployment from rising very much.

“Perhaps most importantly, the political leadership of the European Union (EU) has created an economic recovery plan that encompasses what may be the first step toward a fiscal union. The Recovery and Resilience Fund is a €750 billion addition to the EU budget. The money will be borrowed in the name of the EU and the funds will be available for loans and grants to member countries. The purpose of the Fund is to finance investment projects that will raise a country’s long-term growth potential. It’s a real step toward coordinated fiscal policy. This Fund establishes the principle that the EU can borrow funds and repay the debt with taxes it collects from member countries. Euro-area recovery should continue,” explained Dr Baur.

Extended difficulties in Japan

As the number of daily new COVID-19 cases in Japan is spiking, Dr Baur predicted a “sluggish and prolonged” recovery for Japan.

“The pandemic extended the difficulties the Japanese economy was having trying to recover from an October hike in the value-added tax. Now, however, just as data began to improve a bit, the number of daily new COVID-19 cases is spiking, reaching a new high of 1464 on August 1 according to Worldometer,” said Dr Baur.

Read the full Economic Insights for the month of August here.

Bob Baur

COVID-19 has severely disrupted the world’s economy, plunging it into the worst recession since 1930 and putting an end to the longest economic uptrend in history. According to the National Bureau of Economic Research (NBER), the arbiter of U.S. business cycle dates, February was the peak of the last expansion, ending the 128-month period of expansion.

Dr Bob Baur notes that while many are calling for a prolonged period of economic stagnation, economic data suggests the opposite, with a recovery already under way in much of the world. While NBER is yet to put a date on the end of this recession, it is likely that despite it being the worst since 1930, it may well be the shortest.

First to emerge from the lockdown, China leads the way to recovery

“China was the first country to emerge from the COVID-19 lockdown and data from its government notes economic improvement in March from the collapse in January and February.”

Dr Baur indicates that this economic improvement bodes well for the rest of the world, with industrial output and consumer spending among the data improving:

“Industrial output for those worst two months combined was down 13.5% below the prior year. Production surged in March and surpassed the prior year in April, up 3.9%; further progress was made in May.

“Purchasing manager indices (PMIs) from manufacturing business surveys improved from May and showed faster expansion. According to the Chinese government, industry is mostly back to normal and expecting output in June to exceed May’s annual gain.

“Consumer spending is still somewhat restrained from lingering fear of infection with retail sales disintegrating in January and February, off a combined 23.7% from the same period in 2019. Sales recovered in May but were still down 2.8% from the prior year. Still, demand seems to be improving overall.”

The U.S. economy rushed higher in May as business reopened

“The huge May pop following the April economic collapse was like taking the express elevator back to the ground floor from the sub-subbasement”, said Bob Baur on the V-shaped upwelling after a record contraction.

“By September, the early reopening energy will have dissipated, and the recovery turn more gradual. We expect vigorous third-quarter GDP growth near 10% annualized but followed by a more prolonged recovery with GDP and employment not likely to reach their prior peaks until 2022.

“Regional manufacturing PMIs leapt to near breakeven or more in New York, Philadelphia, Richmond, Kansas City and Dallas, most well above expectations.

“May retail sales sky-rocketed 17.7% over April as consensus forecast only an 8.4% gain.

“May payrolls climbed a monster 2.5 million jobs versus pre-report guesses of a 7.5 million job loss. June payrolls continued the gusher with a record gain of 4.8 million new jobs, 1.6 million above average projections.”

Stay optimistic for now

“The continued revival of world growth should keep the equity uptrend intact at least for a while. There’s a lot of uncertainty around the strength of the rebound into next year and the potential for a second wave of virus activity.

“Looking further ahead, stock valuations as well as bond prices are very high, signs that long-term financial returns may be far less than exciting. The best potential for robust long-term equity profits is a rotation into value and cyclical stocks, a reverse of the investment climate of the last decade.

“For now, though, the recovery seems on track and we’d stay fully invested commensurate with one’s tolerance for risk. Stay optimistic for now.”

By Bob Baur, Chief Global Economist