Equity markets around the globe were on edge as February came to a close. The technology-laden NASDAQ fell nearly 7% from an all-time high on February 12th. The weakness in equity prices came despite very accommodative comments from US Federal Reserve Chairman Jerome Powell during his scheduled two-day Congressional testimony last week. Equity markets became unnerved as government bond yields began to rise at an accelerated pace in the US, Eurozone and particularly the UK. Benchmark interest rates have been rising since the beginning of this year and US interest rates have been climbing since last Summer signaling expectations of improving economic conditions in the months ahead. As long as the rate environment increases gradually, gains can continue in equity markets. But, as we witnessed over the past few weeks, a steep ascent in market interest rates will have an expected adverse impact on risk assets. [chart courtesy Bloomberg LP (c) 2021]
European equities have been rallying yet continue to lag the US and the rest of the world. Since global equities found their pandemic-induced bottom on March 23rd, both the S&P 500 and the MSCI World Indices have rallied over 65% as of last week’s closing levels (12/18/2020) while European shares have climbed just over 60% measured in US dollar terms. While a 60% recovery in approximately three quarters is impressive, it is masked due to currency movement over the period. The Eurostoxx 600 itself has climbed 44% in local currency terms from March 23rd through Friday’s close, and the Euro has rallied over 17% since March 23rd. The disparity in performance suggests a few things to us. First, European investors may have less confidence in their stock markets due to a lack of forceful coordinated continental response to the pandemic. Second, the currency tailwinds for European shares reflect more of a “retreat” from the pandemic flight-to-safe-haven currencies like the Dollar than true economic resiliency. Finally, we are particularly mindful that other stock markets beyond Europe may offer superior growth prospects, which would be especially attractive in a low-growth developed West.
Beyond the rosy headlines of a strong economic recovery and a rally of over 40% in the Shanghai Shenzhen CSI 300 Index from the depths of the pandemic, trouble may be brewing in China’s bond markets. Total debt in China was approaching 325% of GDP in 2019, a point that economies generally struggle. The largest segment of total debt growth from 2018 to 2019 was in the corporate sector, which rose from 165% to 205% of GDP. China’s 2019 corporate debt binge appears to have hit a wall. According to Chinese media reports as much as 69% of private enterprises have defaulted on their outstanding loans so far in 2020 and the festering crisis may impact local governments and state enterprises as well. Further deterioration in the Chinese financial system would obviously have negative implications for the rest of the world.