Why markets are not ready to lose faith in risk, just yet: The Fed and key earnings

Stock markets across Europe are trending lower on Monday, partly down to the grim reality of Covid infection rates passing 100 million world-wide, further restrictions on global travel that has sent airline stocks into a tailspin, and news that pharma giant Merck is abandoning its plan to develop a Covid vaccine, after its two candidates failed to produce a decent immune response in early trials. Interestingly, while stocks in Europe are down 1% + today, Asian shares were higher overnight. The Hang Seng was up 2.4%, after a record high for Tencent and benefitting from news that China attracted more foreign direct investment than the US last year, which could ultimately benefit Chinese companies listed in Hong Kong. In the US, stock futures paint a mixed picture, with the Nasdaq poised to open higher, while the S&P 500 and the Dow Jones are expected to remain flat or slightly lower. 

The bull case for stocks 

Monday trading can bring some unexpected curve balls, in fact we know plenty of people who like to avoid trading on Mondays’, since price action can change direction by the time Tuesday rolls in. The downbeat tone to stock market indices, especially in Europe, is in contrast to the FX market, which is mostly flat, likewise gold is flat too. Commodities are ticking slightly higher, which is why we don’t trust the move lower in equities as the start of something deeper. Of course stock markets are oversold, particularly in the US compared to parts of Europe, of course fund managers are going to say that stock markets need a deep correction, however, we continue to think that there is a decent bull case, especially for the stock markets of countries where the vaccine rollout is going ahead at pace. At this stage of the pandemic, this includes the US, the UK, Israel and the Middle East. Right now, a couple of things could happen re. market performance and vaccine rollout. Firstly, European ex- UK markets could lag behind their peers due to the slow rollout of the vaccine, this could hurt markets including France and Ireland, which had a very strong performance in 2020. Secondly, the worst-case scenario is that the vaccine is deemed unsafe or ineffective as the pandemic progresses and this triggers a risk off event. Interestingly, markets do not seem to be too concerned by rising infection rates in Israel, even though more than 60% of the population have received the covid vaccine. If the same thing was to happen in the US or the UK in the next couple of months, we believe that this could spook the markets. For now, investors still have faith that the vaccine will work, and this is likely to limit any downside for risky assets in the short term, in our view. 

Another good quarter for the tech giants 

This is a blockbuster week for US tech earnings with Apple, Tesla and Facebook all reporting their results. At the time of writing more than 80% of the 60+ companies on the S&P 500 who had already reported results had beaten earnings estimates, thus expectations are for these tech giants to do the same. Tech has reaffirmed its status as a stock market safe haven in recent days. The Nasdaq reached another record high at the end of last week, and today’s early price action suggests that the rally isn’t over yet. Tech stocks are perceived as a haven during this pandemic, largely because lockdowns don’t disrupt the tech sector as much as they do to the other, more cyclical sectors of the economy. If the market is ditching airlines, you can be sure that a tech stock somewhere is rising as investors continue to want exposure to this overbought and expensive sector. 

With covid infection rates growing, and global travel becoming more difficult, the risk is that economic recoveries will be delayed. This could limit interest in the value end of the stock market in the short to medium term, with growth stocks staying in favour. Of course, at some point value stocks will look attractive and investors will dive in, for example airline stocks. However, that day is not today. International Consolidated Airlines Group (IAG), the owner of British Airways, is down more than 7% so far, and it remains more than 30% above last year’s nadir. Thus, there could be further downside before this stock becomes attractive again, especially since Boris Johnson and other governments around the world have dimmed any hopes of a foreign summer getaway. 

Back to tech earnings, the pandemic has split companies into those that have benefitted from extended lockdowns and those that have suffered. Many tech companies have seen their sales jump during the pandemic as the world becomes more digitalised, and we expect this to continue into the last quarter of 2020. Microsoft reports earnings on Tuesday and is expected to show a strong set of earnings on the back of its cloud business and its two recently released gaming consoles, the X Box Series S and X, which both saw huge demand before the holidays. Apple reports on Wednesday and is expected to show another strong quarter for the sale of its hardware, including the delayed release of the iPhone 12, laptops and ipads. 2020 is expected to see Apple’s strongest sales growth in a decade.

Tesla results expected to justify valuation 

Also worth watching will be Tesla. It’s share price has risen seven-fold in the last year, and while Elon Musk has reigned in some of his more wayward ways, he remains an elusive and somewhat volatile leader of the world’s largest car producer by market cap. However, FactSet is expecting Tesla to post a profit for the sixth consecutive quarter and for revenue in 2020 to surpass $10bn, not an insignificant chunk of change, even though this is less than some of the largest European car markers tend to make in an average year. Nevertheless, this is a big achievement for Tesla in a pandemic year. Electric vehicles are heavily linked to tech and making our lives easier, which is part of the current zeitgeist, thus, if we see tech stocks rally this week, we expect Tesla to follow suit. 

The Fed: it’s all about inflation… 

The first Fed meeting of the year on Wednesday is also worth watching, especially in light of the wrangling over the new President, Joe Biden’s, stimulus package. The package, which is worth $1.9bn in its current form, is even facing criticism that it is too big from moderate Republicans, who the Biden administration had been hoping would support the package. This leaves the Fed in a tricky position. It had been poised to hand the baton of stability and financial heavy lifting to the Treasury, which, incidentally, will be headed up by a former Fed chair, Janet Yellen. However, if Congress don’t agree to a deal soon, then the baton may get passed back to the Fed. Price action in financial markets suggests that no one is expecting the Fed to remove the punch bowl anytime soon, and that talk of tapering is too premature. The 10-year Treasury yield is down by 4 basis points on Monday, as covid-fears continue to hit risk sentiment, however, yields remain above 1% for now. Interestingly, inflation protected Treasuries have not sold off at the same rate as non-protected government debt (yields have not risen by as much), which suggests that even if the Fed does raise rates later this year, the market is betting that real interest rates (IR – inflation) will remain extremely low and monetary conditions will remain lose for the long term. Thus, when it comes to monetary policy, we expect the Fed to continue to heap the pressure on the Treasury to boost fiscal support for the economy. The question for investors will be are Powell and co. at the Fed worried about inflation rising out of control so will tighten interest rates faster than the glacial pace currently expected? Currently inflation remains below the 2% target, but it is rising at a decent pace, so a higher rate of inflation is likely to be something that the Fed is watching closely. The question for Wednesday’s meeting is, how tolerant of higher inflation will the Fed be once it takes hold in the US economy. Any real concern on the face of Jay Powell could send shivers through financial markets, weigh heavily on tech shares and send the dollar into recovery mode.