Stock markets in China and the U.S. have held up fairly well in the middle of this global and historic pandemic. But are central bank backstops enough? Or will some economic fundamentals eventually come in to play?
Here’s a look at three issues that are headwinds for the U.S. stock market in particular, according to investment strategists at Glenmede. They’re convinced fundamentals will matter again one of these days.
- Earnings misses — They’re coming, wrote Glenmede strategists Jason Pride and Mike Reynolds in a client note on Monday. They’re estimating large cap U.S. corporate profits falling between 50% and 90%. Ninety!
- Consumers tap out — We all know that 22 million have lost their jobs. Many will be rehired. But who is calculating for the untold millions who lost bonuses they consider huge parts of their annual income, or were forced into pay cuts ranging from 5% to 25%. Consumers and corporates may prefer to save than spend, Glenmede’s strategists believe.
- Trade war reboot — This is becoming consensus now. The U.S. is not going back to a China-centric model where multinationals use China as their global manufacturing hub. Look for some key, national security items to be forced out of China. If not, post-pandemic business could prompt “new regulations and tariffs in an effort to reduce dependence on other countries for essential goods like antibiotics, medical equipment and supplies,” Pride and Reynolds wrote.
The S&P 500 is up over 12% from its lows on the year. China’s stock market has beaten the U.S. during the pandemic, thanks in part to the People’s Bank of China and state financial institutions buying up equities.
China is still healing from its bout with the new SARS coronavirus, first discovered in Hubei province back in December. Investors are banking on more stimulus from Beijing.
This is what China looks like today:
China’s real GDP growth fell 6.8% year-over-year in the first quarter, erasing all of the growth from the previous quarter, and then some. Quarter-on-quarter growth was down by 9.8%.
Growth of industrial production (IP), fixed asset investment (FAI) and retail sales rebounded — but the rebound is still negative. That’s a rebound of -1.1% annualized for IP, -9.4% for FAI and -15.8% for retail in March. It was -13.5%, -24.5% and -20.5%, respectively, in January-February.
IP growth, which surprised to the upside in March, could face strong headwinds on slumping external demand and a post-pandemic shift out of China as Japan is now willing to fork over $2.2 billion to get its companies out of there.
“Despite its initial success in containing COVID-19, we believe hopes of a quick recovery are dimming,” says Nomura chief China economist, Ting Lu, citing the U.S. and Europe recession and the risk of a second wave of coronavirus infections in China.
The pandemic sell-off in the stock market did not last that long. In fact, it was shorter lived than the pandemic.
It looks increasingly likely that the crisis has already peaked in the Tri-State area of New York, New Jersey and Connecticut.
But in China, the aftershocks are still being many weeks after lockdowns have been lifted.
China’s services economy is struggling, especially in high-touch sectors such as gyms, cinemas, hairdressers, air travel and retail. Shanghai Disneyland is still closed.
Worse yet, new coronavirus outbreaks in China along the country’s northern border with Russia are making people nervous that this new SARS coronavirus is more stubborn than the first SARS, which lasted in China for about 8 months. If this one lasts as long, it would take us to August, something few have the patience to wait for.
Regarding the recent flare-up of new cases in Singapore and Japan: both countries avoided the initial outbreak, so this is more like their first wave than a second one, says Steven Blitz, chief economist for TS Lombard.
Blitz has even more reasons why he thinks equity markets will fall throughout the summer. He has seven, to be exact.
Like Glenmede, earnings shortfalls is top-of-mind. It will determine how businesses start next year.
“The amount of earnings decline projected for this year determines the starting point for expected earnings in 2021,” he says. He is forecasting earnings growth in 2021 in single digits thanks in part to wage destruction in the core economies.
Blitz likes the Fed, and is wary of betting against it, but thinks fundamentals still play a role.
“Even the most optimistic investors are more uncertain than they were before the crisis,” he says. “With current valuations unsustainably high, the market will drop sharply again, irrespective of Fed actions.”
In riskier markets, BlackRock BLK opted to downgrade emerging market debt on Monday. Local currency bonds are a potential bust. Default risk could also be underpriced on hard currency bonds, especially if it’s an energy related company.
For the higher yielding local currency bonds, the risk of further currency declines in some emerging markets could wipe out interest income for foreign investors desperate for yield. Global fund managers who started off 2020 excited about a continuation of strong demand for yield among their investor base have been caught in the wrong place at the wrong time as the pandemic pulled the rug out from under that trade in late January.
The coronavirus shock is unprecedented and its impact is worse than the housing bubble popping in 2008.
The pandemic’s cumulative hit to growth is likely to be lower if elected officials in the U.S., Europe, and the Chinese government, flood the gates with overwhelming fiscal and monetary policy to bridge businesses and households and keep securities markets liquid.
Making matters worse, this is an election year so political parties will use the crisis as a means to point blame or weaken an opponent.
That could be problematic for further stimulus measures should the economic fallout be worse than expected.
If the policy response is better in China, the money flow will go there.
If Washington and the European Union fail to deliver in a successful and timely fashion, BlackRock thinks it will cause “lasting damage” to the economy.
This article originally appeared on Forbes.
