Growth Strikes Back

The world economy is set to grow again in the next quarter. Signs of recovery are increasing and we believe the trajectory is clear. The situation is not without risk but, to us, the lack of enthusiasm expressed by many is unjustified. This return to growth is taking place in an environment of low interest rates and supported by broad fiscal stimuli implemented across a large number of economies. We believe that, during the summer, most 2020/2021 growth forecasts will therefore be revised upwards, motivating investors to look beyond the effect of falling interest rates. In addition, the equity risk premium remains intact, suggesting that equity markets will continue to rise. The “Summertime Sadness” will likely not last all summer.

What’s Next?

The recovery is here, no doubt about it

This is the central question: are we, or are we not, witnessing a recovery commensurate with the shock we have just experienced? In view of the data we collect daily, we think it is beyond doubt.

First of all, in terms of data, the economic recovery is shaking up a large number of countries, with the US in the lead. We regularly communicate the message delivered by our global Growth Nowcaster. Since the end of May, our indicator has recovered 60% of its fall in the space of a month and a half. Similarly, 78% of the data that make up our global indicator is improving.

These figures alone should be enough to convince our reader that the recovery is well and truly underway, but the more skeptical will want more details. Our growth indicator for the US recovered 72% of its decline in one month, for the Eurozone, 40%; Switzerland, 98% and Australia, 38%. While some countries may leave room for doubt (Canada recovered only 20% of its capacity and the UK just 10%), it remains a safe bet that this is likely due to a delay in data collection (Canada) or late implementation of quarantine measures (the UK). The same applies to India, South Africa and Malaysia, which are also lagging behind. Everywhere else, the recovery is rapid and comprehensive. If there is still any doubt, one need only consider China’s recovery, which looks to be complete, according to our Growth Nowcaster. Having floundered at extremely low levels, our growth indicator now indicates that the economic situation has normalised. As of 7 July, 2020, our indicator for China has returned to positive territory, led by a recovery in consumption and a resumption of global demand.

These various developments indicated by the 1,300 data series that are combined and analysed daily in our Nowcasters are clearly corroborated by other data sources:

• Our Newscaster, which analyses media reporting of the growth theme, also shows a rapid economic improvement.
• Economic surprise indices are on the rise overall. Within the G10, not all have returned to positive territory but their improvement is now evident. On 17 June, 20% of them were improving. Now, in mid-July, more than 50% of these indicators are improving.
• World trade indicators are improving. The Baltic Dry has increased by 400% since its low point in mid-May. This is an improvement similar to that observed between January 2018 and September 2019.
• Oil and industrial metals prices are delivering the same message: WTI (6-month futures) prices have risen by 80% overall; copper prices have recovered 40% from their lows.

Whatever angle you look at it from, the answer is the same: the recovery is there and it is strong.

Are we all convinced?

This question deserves our full attention: is the average investor convinced by what is going on in the economy? We do not think so, and have already communicated widely on this subject: the recovery is in the numbers, but not in the portfolios.

Is it any wonder that economists’ forecasts are still at half-mast? Take the case of the US. For private economists, the median forecast for US growth in 2020 is -5.7%, and +4% in 2021. The first of these consensus forecasts is a very mixed conclusion: the fourth quartile of these forecasts for 2020 sees growth at -6%. The upward dispersion is much greater and the first quartile of these forecasts anticipates -4.5% in 2020 and +5% in 2021, i.e. complete economic normalisation in two years. However, there are still a few economists in the US who foresee -9.5% growth this year and zero growth next year.

What about the official economists? They too are generally pessimistic. Again, using the US as an example, the Fed is forecasting -6.5% for 2020, the OECD, -7.3% and the IMF, -8%. Overall, the economic forecasts are probably starting to become outdated, failing to incorporate two key elements:

• The different fiscal packages put forward by most developed economies, which are approaching 5% of GDP on average, and up to 10% in the case of Germany and the US.
• The various signs of recovery that have been accumulating since the beginning of June.

Analyst estimates for earnings also reflect wide dispersion among market participants. Currently, the average estimate for 2020 EPS for the S&P 500 is USD 128, with a standard deviation of USD 24.69. To put that number in context, it is nearly five times larger than the dispersion in estimates over the last couple of years and well above the dispersion seen in 2009: the standard deviation in 2019 EPS estimates in July 2019 was USD 4.89, while it was USD 5.41 for 2018 EPS in July 2018. Even in July 2009, the dispersion among analysts for EPS was just USD 9.09.

In light of these various observations, it seems logical to expect two elements to support markets in the short term: (1) a marked recovery, and (2) macro data surprising to the upside. These two elements should continue to fuel an improvement in overall investor sentiment. It should be noted that skew in equity indices remains very high, the equity positioning of different types of investors remains low and credit spreads and volatility still have room for more enthusiasm. What is probably concerning many is the valuation argument: has the recovery train already passed?

But stocks are already expensive!

We have already communicated on this subject many times: growth assets have still not entered the expensive zone according to our valuation indicators. Another way of looking at it is to extract the equity risk premium from stock prices, i.e., the compensation required by investors to bear equity risk, once the impact of interest rates and credit spreads has been eliminated. In the case of the S&P 500, this risk premium averaged 3.5% across 2016-2020. It has soared since the end of 2018, from around 2.58% to 4.36% just before the recent crisis. Since then, this premium has moved only slightly and is still around 4%, close to January 2009 levels. This premium could contract by 1% over the next 18 months without any real surprise given the extent of the economic recovery, leading the S&P 500 to reach higher levels (+20%) provided that long-term interest rates change only slightly. With real 10-year yields remaining negative (-0.75%), the bond world is probably the most pessimistic market segment, and that is a good thing: a 1% rise in rates could cost growth assets and moderate the impact of the recovery.

In conclusion, the signs are not all positive: the earnings season and the US elections could shake markets in the medium term. However, we do not think the investment community is sufficiently convinced of the recovery. By lowering rates, the Fed has partially convinced investors and markets have regained some colour, but the fiscal packages, their impact and the speed of economic normalisation leave investors unmoved for the time being. We believe that it won’t last and that this “summertime sadness” will have a happy ending.

Unigestion Nowcasting