Market overview

Thanks to an astonishing final spurt, the global stock markets took another big step in May away from their mid-March lows. The MSCI AC World Index rose by an impressive 35% from March 23 to the end of May, the same level as in October 2019. Other assets such as corporate and emerging-market bonds also performed well in May. However, by far the biggest gain came from oil, where the price of West Texas Intermediate (WTI) rose by almost 80% to around 33 dollars per barrel, although many producers are still unlikely to make a profit at these levels.

The economic data and news on the Covid-19 pandemic make this market euphoria certainly seem surprising. But a glance at government aid packages and the balance sheets of the central banks explains a lot. France and Germany surprised with a joint push for a trillion-euro European aid package, which some quickly interpreted as an about-face turn in German policy, as the design shows clear features of a transfer union and joint liability, to which the German government had been opposed. However, some Nordic European-Union (EU) countries and Austria are still critical of the plan. 

In May, meanwhile, the major central banks again gave numerous indications that there would be no lack of support. The aid provided so far has had some impacts that will certainly be long-lasting. The U.S. Federal Reserve (Fed) now has a balance sheet totaling 7.1 trillion dollars, up from 4.1 trillion dollars in early March. As a reminder, during the banking crisis at the end of 2008, the Fed reacted with less than half this level of balance-sheet expansion, and even at the end of 2010 its balance sheet was only 2.5 trillion dollars. Ten years on, we expect total assets to rise to over 10 trillion dollars by the end of 2020. The increase in the European Central Bank (ECB) balance sheet from 4.7 trillion to 5.6 trillion euros during the crisis so far seems relatively modest, but the bank had already doubled its balance sheet since 2015. 

Government debt has also reached new record levels worldwide. In the United States alone, it is likely to increase by around 20 percentage points this year in relation to gross domestic product (GDP) to exceed 100%, and in Europe by around 10 percentage points, according to our estimates. It is no secret that the upturn in markets reflects this monetary impetus and is therefore perhaps shaky, and this too is reflected in market developments. Value stocks have historically always been the first choice when a new upswing begins but they have had only a few strong days. The rally is once more being driven by growth stocks, which in May gained 6.5%, whereas value stocks gained only 2.9%.^[1] A typical month, therefore, because the value stocks have only managed to outpace growth stocks in two months in the past two years, and then only minimally. The weakness of value stocks over the past few months suggests the markets know that the current upswing is very atypical. 

This brings us to the economic data which remained at record lows in May in many countries, though some of the data also showed improvements over April. The Purchasing Managers' Indices (PMIs) can be taken as an example. They stabilized at a low level in May and improved in some cases. As the course of the pandemic, mobility data and consumption correlate very strongly, it is not surprising that the low point in many cases occurred in April, especially in Europe. In the United States, consumption slumped by a full 13.6% in April, and May may have been better according to some indications. In Germany, on the other hand, the decline was only 6.5% in April, possibly supported by a 2.5% year-on-year increase in gross earnings. Other data, such as unemployment figures, continue to show a negative trend. In the United States the unemployment rate at the end of May is likely to be close to the 20% mark. Global growth forecasts for 2020 are also still being revised down. At the end of the month, ECB President Christine Lagarde pointed out that she expects a decline in economic output for the Eurozone this year at the lower end of ECB expectations of -8% to -12%. In China the PMIs improved slightly and thus remain above 50, but the sub-indicator for new orders from abroad was only 35.3 points. As in many parts of the world, there is more produced than is currently consumed, inventories are likely to build up.  

The fact that it will still take some time before global supply chains run smoothly again is due to the slow global spread of the pandemic. New hotspots are still emerging. In May, Latin America joined the United States as the center of the pandemic, according to the World Health Organization. In the United States, the number of new infections per day is still over 20,000, while in France, Spain, Italy and Germany, the combined figure fell below 1,000 for the first time at the end of May, despite greater easing measures. Worldwide, the number of daily new infections rose from around 80,000 to 100,000 in the course of May. 

In the midst of the pandemic there are new and old rifts opening. The most worrying for the markets is likely to be the resurgent trade conflict between the United States and China. The United States has commented on the protests in Hong Kong and the crackdown by the Chinese government and is simultaneously increasing the pressure on the Chinese technology sector. But unrest is also taking place in the United States, possibly to a greater extent than at any time since 1968. This is leading President Donald Trump to consider sending the National Guard to those cities where he believes mayors and governors are not being tough enough on protesters. A development that goes remarkably unnoticed by markets.

Outlook and changes

As we held our quarterly strategy meeting at the end of May, we will now discuss both strategic and tactical assessments. In June, we believe three themes should dominate markets: 1. the Chinese-American trade conflict; 2. the course of the pandemic in the wake of easing lockdown measures, and consumers' reaction; and 3. the progress of the European aid package. In addition, there is Brexit. As London can only unilaterally obtain an extension of the transition period this month. In the midst of UK's comparatively chaotic response to the pandemic and the internal party squabbles over the further handling of Boris Johnson's most important advisor – Dominic Cummings (who did not adhere to the lockdown rules) – it is more difficult than ever to assess how far London and Brussels will take their tactical games in this round of negotiations. An unintended slide into a no-deal Brexit also remains a possible scenario. However, this may not affect global markets substantially.
The results of the strategy meeting can be summarized as follows: After the sharp downturn in the first half of the year, we expect a slow recovery, which will likely bring a return to end-2019 output levels by the end of 2022. We expect further outbreaks of Covid-19 infections but no need for lockdowns seen in March / April. We expect further support from central banks, which in turn should keep government-bond yields extremely low. We see support for corporate bonds, also in the high-yield segment, despite higher expected default rates in the latter. We still do not see any weakness emerging in the U.S. dollar.

After the recent rises, we expect only limited price potential for equities, with no geographical preference.
From a tactical perspective, we have made small changes. Even though, we are aware of the fragility of the upswing, we believe some cyclical sectors that previously suffered particularly badly can regain some ground. We have therefore upgraded the basic materials sector to "neutral." We believe that a significant recovery is possible for the mining sector in particular, due to the recovery in demand combined with the sector's ability to sell at relatively high prices because of its oligopolistic structure. In the industrial sector, we also expect significantly better figures, especially in machinery, due to catch-up effects. By contrast, we are downgrading the real-estate sector to underweight. Apart of that, we maintain our preference for the technology and healthcare sectors. 

In the bond segment we remain optimistic about some corporate and emerging-market bonds from a tactical point of view. Compared with the previous month we have also now returned U.S. investment-grade corporate bonds to positive. The fact that the Fed is ready to buy in this segment provides clear support. However, as strong demand resurfaces, including from the private sector, there should be somewhat less pressure from the supply side. The amount of capital raised so far this year in excess of one trillion dollars was almost double the level of the same period last year.

We have a largely neutral position on government bonds. Although progress on the European aid fund (the Merkel-Macron Initiative) could in the future lead to higher Bund yields and lower premiums in the peripheral countries, the markets have already anticipated most of this.
As far as currencies are concerned, we see the euro-dollar pair trading sideways for the time being, while we expect further pressure on the renminbi and pound sterling.

The multi-asset perspective

From a portfolio perspective, two different worlds must be reconciled. On the one hand, the fundamentals: An economic upswing that after a short-term catch-up could easily drag on for an agonizingly long time. In addition, political risks have risen significantly. Together these suggest that markets have recovered too fast and too much. Another complicating factor is that the rescue packages and liquidity injections implemented by governments and central banks, and the continuing prospect of ultra-low government-bond yields, means there seems to be no way around equities. The exception to that may be corporate bonds, which also still look interesting, especially since they are still trading at a significant discount compared to the pre-crisis period. But the past has shown that central-bank measures in particular are priced in early, i.e. when they are announced. And that if implementation of these measures proves problematic or is less effective for the real economy than expected, disillusionment may set in. There might also be a risk from another angle: a better than expected economic recovery. Why is this a risk? Because it could lead to the record aid packages being cut back. Overall, looking at the broad picture, the fact that markets are high when fundamentals look poor and risks both economic and political are high argues in favor of a slightly more defensive stance.

Past performance of major financial assets

Total return of major financial assets year-to-date and past month

Tactical view (1 to 3 months)

• The focus of our tactical view for fixed income is on trends in bond prices.
•   Positive view
•   Neutral view
•   Negative view

Strategic view until June 2021

• The focus of our strategic view for sovereign bonds is on bond prices.
• For corporates, securitized/specialties and emerging-market bonds in U.S. dollars, the signals depict the option-adjusted spread over U.S. Treasuries. For bonds denominated in euros, the illustration depicts the spread in comparison with German Bunds. Both spread and sovereign-bond-yield trends influence the bond value. For investors seeking to profit only from spread trends, a hedge against changing interest rates may be a consideration.

• The colors illustrate the return opportunities for long-only investors.
•   Positive return potential for long-only investors
•   Limited return opportunity as well as downside risk
•   Negative return potential for long-only investors