May saw a continuation of the recovery of market sentiment seen in April. Equity markets continued to rally and towards the end of the month US markets reached levels not seen since the end of February. Many countries in Europe and Asia, along with some American states, initiated phased plans to exit lockdown, boosting hopes that the economies are back on the path to normality. The oil price strengthened due to a decline in US oil inventories and talk of further OPEC supply cuts. Despite broad market optimism, the prospect of a second spike in Covid-19 infections remains a possibility, and the full economic implications of lockdown and fiscal and monetary stimulus remain unclear.

US equity markets continued their strong rebound from March lows, with the MSCI US index ending the month up 9.75%. The reopening of many states spurred hopes that the country may be past the depths of lockdown. This, however, was against a backdrop of poor economic data, with retail sales falling 17.2% in April and over 40 million Americans applying for first time unemployment benefits. The Federal Reserve has stated that uptake of its lending facilities available to purchase risk assets is as low as 4% of the total $2.6trn available. The fact that facilities are available may have been enough to reassure markets, by indicating the Federal Reserve’s willingness to act as a buyer of last resort. Whilst in the short term this has worked to support the market, the long-term implications of such a policy is less clear, with either deficits or increasing tax rates proposed to pay for the stimulus.

European equity markets also rallied in May, with MSCI Europe ex UK rising 6.67%. Unemployment figures were better than expected in April, only increasing 20 basis points to 7.3%, compared to the forecasted 8.2%. The enrolment of 40 million people in government-subsidised furlough schemes across the continent has undoubtedly cushioned the effect on unemployment to date. In May, significantly reduced energy prices saw deflationary fears return as 12 of 19 eurozone countries experienced negative price growth. Towards the end of the month, Ursula von der Leyen, President of the European Commission, unveiled a proposal for €500bn of grants and €250bn of loans, taking EU stimulus packages to €1.85trn in total. This was despite the earlier German constitutional court ruling ordering the German government to ask the ECB for a “proportionality assessment” of their bond purchasing programme. The group known as the ‘frugal four’ (Austria, Denmark, Sweden and the Netherlands) are also set to resist the plan, preferring a loan only package. Southern European countries have thus far rejected this idea on the grounds of already high levels of national debt. There was less contention around Germany’s announcement of a further €130 billion national stimulus package. The package centres around consumer demand and aims to boost the economy and safeguard the jobs of the 7 million workers who are currently furloughed in the country.

The MSCI UK index mirrored the rallies in European and US stocks, up 5.57% in May. Measures to allow construction and industrial activity along socially distanced guidelines boosted economic activity in the manufacturing sector, as evidenced by the increase in the sector PMI from 32.6 to 40.7. There was also a notable rebound in the Services PMI, but with non-essential retail stores not due to reopen until 15 June, activity is still significantly below pre-crisis levels. During May, Chancellor, Rishi Sunak, announced an extension to the government furlough scheme to the end of October 2020, but employers will be required to start making contributions to worker pay from August. With 8.4m workers currently making use of the scheme, Sunak acknowledged that job losses were likely. He is however expected to unveil a stimulus package in July to counteract the continuing economic damage of the lockdown, focusing specifically on infrastructure spending and training for those out of work. UK three-year gilts were auctioned off at negative rates in May, prompting the Bank of England to contemplate negative interest rates for the first time in history.  Only days earlier, Andrew Bailey had ruled out the BoE implementing the policy. The policy certainly polarises opinion with detractors arguing it decreases the profitability of high street banks and, in turn, credit availability, and proponents arguing that negative rates effectively force banks to lend spare cash which stimulates spending in the economy.

China’s market recovery slowed in May, with the MSCI China only rising +2.39%. Markets rallied early in the month with signs of economic activity returning to normal; industrial production for April was up +3.9% on 2019 and retail sales declined at a less severe -7.5% year on year. However, investor optimism was brought to a halt with the announcement of China’s new security law for Hong Kong. The move reignited US-China tensions and led to President Trump revoking Hong Kong’s preferential trading status and imposing work and travel restrictions on Chinese and Hong Kong officials deemed as being involved in ‘eroding Hong Kong’s autonomy’.  The return of expansionary readings for both Manufacturing and Services PMIs at month end did however help to restore positive market sentiment.

The MSCI Emerging Markets index rose a modest +3.14% in May. As the infection rates fell across most developed nations, the path back to normalcy began to be mapped. In contrast, active cases of the virus in some developing nations, notably, Brazil, Mexico and India, began to surge. The handling of the crisis in Brazil in particular, had international investors concerned. Elsewhere in South America, Argentina failed to avoid its ninth sovereign default, demonstrating how emerging markets with less fiscal and monetary bandwidth are struggling to contain the economic fallout of Covid-19. The Federal Reserve and the IMF have extended crisis support to some developing countries, but this is contingent on various factors such as central bank independence and credible policymaking which has led some countries to resist the aid.

May saw developed market equities continue on the upward trajectory seen in April, bolstered by the phased reopening of most economies. Pressure on emerging markets continued to build, however, despite selective interventions from the Federal Reserve and IMF. Global governments and economies must now navigate the ‘exit plan’. Short term deflationary pressure and the possibility of an extended period of negative real rates present challenges in an environment where medium to long-term inflation would be expected. Investors are adapting to an altered risk-reward dynamic as Central Banks have flooded markets with liquidity, whilst economies have been supported by unprecedented levels of fiscal stimulus. Currently, investors are looking past the challenges associated with unwinding these interventions, as reflected by strong market rebounds. We remain relatively defensive in our asset allocation recommendations but encourage clients to take a long-term view on their investments. We see a period of uncertainty ahead and are happy to be selective in the regions and strategies which we advocate.

Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice as at the date above, both of which may be the subject of change in the future.  The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice.  Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority.  As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling.  Investments in stocks and shares should therefore be viewed as a medium to long-term investment.  Past performance is not a guide to the future.