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Market Update from John Redwood of Charles Stanley & Co

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The movements of share markets are dominated by views of how long the lockdowns will last and therefore how much of the temporary damage to companies and economies becomes more permanent. Yesterday the bears were in the ascendant, as the severity of the US epidemic seemed worse, whilst there are few signs of early relief in Europe. The European share indices, the S&P 500 and the Indian Index all saw falls. The news background on the virus is also becoming more disturbing, as political oppositions nervously move from support for governments fighting what are seen as a series of parallel national crises, to questioning strategies and competence of governments at handling the disease. In the USA, Joe Biden, Trump’s front running challenger for the Democrats, has appeared side-lined by the crisis, but the Mayor of New York through daily news conferences offers criticism and alternative approaches to Washington.

 

Attention now turns to the response of the European Union to the pandemic. The European Central Bank has made its substantial contribution through expanded QE programmes and various liquidity and banking measures. The national and EU authorities are finding coming up with large fiscal responses a bit more difficult, given EU rules and overlapping responsibilities. The EU has announced relaxations of state aid rules to allow member states to direct cash to businesses in trouble or needing financial support to carry employee costs when they are short of revenue. It has allowed states some fiscal flexibility for the short term, recognising that states will want to increase spending at a time when tax revenues will plunge with inevitable consequences for their budget deficits and build-up of state debt. This leaves the worst affected member states like Italy asking what financial support there will be for them from the EU itself.

 

The southern countries with larger state debts and past deficit problems have always wanted the EU to provide more cash through the issue of Euro bonds backed by all Euro area states. The northern countries led by Germany have always resisted, insisting that each member state limits its deficit and reduces its state debt to 60% of GDP to preserve the financial discipline of the zone. On this occasion Germany is prepared to countenance lending to countries like Italy from the European Stability Mechanism funds. Any such loans would come with conditions attached to show some longer-term commitment to the strict rules on debts and deficits. This is not attractive to the potential borrowers. Others think a half-way house would be for the EU to set up an EU fund that provided extra cash to distressed countries suffering from the virus, either as grants or easy terms loans. The southern countries would prefer the issue of Coronabonds underwritten by the whole Euro area with the proceeds spent where they are most needed.

 

A further possible compromise would be to all agree that the European Investment Bank should add health-related spending to its predominantly green agenda for loans to economic activity throughout the EU, with measures to increase the EIB’s capacity to lend. The Germans could probably accept that as it continues a current system for EU-wide lending and is supervised by an Institution that requires certain standards be met by borrowers. The southern countries would need some reassurance that the categories of loan they need for the crisis would be available on acceptable terms to them.

 

Meanwhile economies deteriorate at pace and the member states have substantial cash needs that will require funding in their domestic bond markets. These issues will go ahead whatever the rules still say, resulting in further large debt build-ups amongst the weaker countries. The Euro remains a half-completed project, with a reluctance to put the weight of the taxpayers of the whole zone behind the debts of individual country parts of it. The larger deficits the virus will cause will be an additional strain on the architecture and on market valuations of the debts of the weaker countries.

 

Yesterday saw a big leap in Universal credit applications in the UK whilst today will see some dreadful unemployment numbers in the USA. The reality of the economic damage is now coming home to people in hard numbers, each revealing the collapse in paid employment and the severe fall in demand from the closures. Three or four weeks of this creates a big hole but recovery could be relatively strong and quick if all restraining measures were lifted soon. On the more likely scenario that substantial restrictions in the USA and Europe continue for longer, markets are right to worry about the blizzard of cut dividends, capital reconstructions and disappearing profits to come.

 

Remember, if you need any help or advice you can reach Apex CB Financial Planning on 01202 622223

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