A universally bullish period has seen equity markets rally across the board, taking US stocks right back up to an unchanged position for the year.
Other markets have also been strong, but have yet to regain pre-COVID-19 levels. These moves have caused some consternation but overall there is a solid rationale in the light of sovereign bond yields. The US ‘risk-free’ rate, the ten-year bond yield, has more than halved over the year (1.9% down to 0.8% currently), with a similar pattern in the UK, leaving stocks looking cheap (a jump in the equity risk premium if preferred).
Of course, this has to be balanced against what the COVID-19 recession will do to corporate earnings, which will be significantly lower in many areas. At which point it gets much more complex and one can no longer talk about ‘markets’ in general terms (something of a problem for ‘asset allocators’ I fear), it is down to the mix of companies within the various indices/markets. The US market has (rightly) benefitted from its heavy weighting in major technology-related companies (Apple, Microsoft, Amazon, Alphabet, Facebook, etc.), who are likely to see little earnings damage or gains, hence its out-performance.
The actions of the US Federal Reserve in support of credit markets have been critical (and very welcome). Companies have been able to raise funds, at highly competitive rates, either to bolster their finances or establish firepower for expansion. Naturally, it has been easier and cheaper for corporates with good balance sheets to raise funds, something that will only accelerate the trend to the strong getting stronger.
Last month we talked about there being bargains to be found in some ‘value’ areas, highlighting the contrast between the winners in technology and losers in big oil and banks. This has been borne out with a snap back in both the oils and the banks, both of the S&P sector indices being up around 37% over the four weeks. There does appear to be a lot of discussion around the opportunities for value vs. growth investing at present, we would just observe that such broad categorisations do tend to miss a lot. We prefer to buy stakes in high quality companies with proven growth prospects at fair prices, which could be called either.
We consider that Morgan Stanley is one of the best-placed of the US banks at present. It was interesting to listen to the generally optimistic comments from James Gorman, the Chief Executive of Morgan Stanley, on 9 June. On reserving, he said: “I doubt very much it will be the level we're at in Q1. And we're obviously seeing some positions as spreads are tightening that are recovering. So it's a bit of a mixed bag. But I think the worst -- the worst is clearly behind us. - So will there be more provisions? Yes. There'll be some. Will they be at the level of first quarter? I very much doubt it.” While on the topic of stress-tests, he observed: “I think it's interesting. What the Fed actually puts in the models and how it spits out the answer on the COVID remains to be seen. Clearly, they've got to look at all sorts of different recovery scenarios driven by unemployment numbers - But the experience we are living right now would suggest that we're really well capitalized for this business environment. I don't regret us and the other banks choosing to hold our buybacks. I think it was the right thing to do at the time. But we've proven that we're well capitalized. - I think the fiscal work and the monetary stimulus from the Fed have been positives.” While he was also interesting on the topic of dividends: “We should be paying out our dividend. I've said that right from the get-go. The dividend payout for all the big banks, I think, is about 30% of their total distribution. We made 3/4 of our dividend in Q1. We're going to do at least as well in Q2 and we'll talk about that. We cover -- we're going to cover our dividend very easily this year.”
Markets have recovered a lot of ground quickly and, while this is reasonably rational (as above), the next stage of the economic recovery remains uncertain. So it would not be surprising to see something of a re-tracing of recent moves over the next few weeks.