US fiscal policy paralysis signalling dangers ahead
Despite growing concerns about the current deadlock in extending the Covid relief bills, US stock markets have remained remarkably calm. We feel this was partly supported by more encouraging news on the vaccine front and partly by the latest Federal Reserve policy meeting where the central bank unsurprisingly pledged to keep its benchmark rate near zero and to continue with its aggressive QE program to keep markets functioning smoothly. Indeed, the VIX ‘fear gauge’ index remained subdued last week, hovering near its 6 months lows and still below its 200 days moving average while cash parked in US money market funds which had its first notable blip up in the previous week, dropped back down to its 4 month lows. Neither of these two measures which we have been keeping a close eye on is indicating any immediate correction concerns regarding the stock market.
Nevertheless, unemployment insurance benefits and eviction moratorium for federally insured homes having already expired and the $3.5trn stimulus package approved by the US House of Representatives back in May has shrunk to to $1trn in the counter-proposals made by the Republican-controlled Senate. With Democrats demanding the removal of virus-related liability shield for businesses which they deem would only encourage firms not to follow the strict CDC guidelines to contain the contagion, law makers still seem far apart in reaching a consensus.
With the forward looking US weekly jobless claims rising for a second week in a row, and other economic data suggesting that the economic recovery is faltering, we feel that stimulus measures have become even more vital in keeping markets calm before the summer recess over the next two weeks. The dangers are that the relief programs will become highly politicised and with the latest polls suggesting growing dissatisfaction about Mr Trump’s handling of the economy, further hurting his reelection chances in November, the House Democrats seem to be in a strong position to drag this out and stick to their demands.
Japan stocks looking increasingly vulnerable in the shorter term
As far as our own stock market in Japan is concerned, the recent correction in stocks have hardly come as a surprise. As we had explained last week, despite Japanese stocks’ relative under-performance to those in the US, their attractive valuations, not to mention, their strong balance sheets, they provide little short term downside protection to any potential global market rout. With the Covid-19 infections in Japan hitting record daily numbers while the Abe government is sitting on the sidelines doing very little to contain the spread, anxiety levels are clearly rising.
As we have also explained, the government’s ‘Go To Travel’ campaign to boost domestic tourism has been a good indication of where its priorities lie despite the growing fears of the virus spreading in rural areas. With still not much more than 800K tests having been conducted to date, Japanese policy makers seem to have been in a deep coma in the past few months and have left them flying blind in how far the contagion has spread as infections are now hitting daily records in other towns and cities outside of the Kanto region. Thankfully, fatality rates have thus far remained fairly low despite Japan’s ageing demographics but that could also turn for the worse.
Another major headwind has come from the current earnings season as corporations have been posting notably poor June-ending quarterly results as the full impact of the pandemic has now been felt. Moreover, as firms remain highly cautious in their outlook, their full term forecasts which are a quarter late are largely undershooting market expectations. Indeed, this has been one of the first quarterly results seasons for a while when poor corporate earnings are not being brushed aside as largely discounted despite what looks to us as the earnings bottoming out. We suspect market participants seem to be more concerned about the pace of the recovery from here. With the US dollar retreating on real negative interest rates and on anticipation for more monetary stimulus, the growing probability of yen/dollar rate breaking below that psychological 100 level in the near term has become yet another point of concern regarding Corporate Japan’s earnings outlook.