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Ahead of the curve: Jerome Powell will not be fooled by a V for a U

June 17, 2020

A commentary by Jürgen Lukasser, Chief Investment Officer of LGT Bank Österreich, on equity markets, which in recent weeks have made a remarkable recovery despite weak macroeconomic conditions.

Ahead of the curve: Europe in a moral trap

The broad S&P 500 Index is already approaching pre-crisis levels, and the NASDAQ 100 Index has already set a new all-time record. How does that fit together? The decisive factor is the expectations anticipated by the stock markets. Analysts like to talk about a V-shaped or a U-shaped scenario. The V-shaped scenario is based on a rapid and sharp economic slump, followed by a dynamic recovery. The U-shaped scenario also assumes an economic recovery, but with a more timid start and slower progression. Although under normal circumstances the labour market is considered a lagging indicator - labour market data only improve after an economic upswing - it is currently the linchpin. In April 2020 some 20 million jobs were lost as a result of social distancing. This is an epoch-making figure, as the total number of jobs lost in all recessions in the U.S. dates back to 1945. Without decisive improvements on this front, an economic comeback is hardly conceivable, and the form and duration of the economic recovery will probably be decided in this sector. The publication of the number of new jobs created in the private sector for the month of May promptly brought a big surprise: instead of a further 6.7 million jobs being cut, almost 3.1 million new jobs were created. The job miracle occurred primarily in the hard-hit service sector. The stock markets ignited fireworks, the incumbent US president rejoiced and even spoke of the strongest economic comeback in history. With a view to the upcoming presidential elections, there is also a certain amount of purposeful optimism. Fed Chairman Jerome Powell, on the other hand, is pleased to note the sign of life in the labour market, while at the same time admonishing realism: it will be years before the US labour market can return to the strength of last year. Accordingly, key interest rates have been left unchanged close to the zero line and no rate hikes have been announced at least until 2022. In addition, the Federal Reserve will continue to buy up fixed-interest instruments for at least USD 120 billion. Jerome Powell is thus keeping his foot on the gas pedal, and the central bank is in any case determined to take all measures to support the economy.

What does this mean for the capital markets? The zero interest rate policy will be extended for years. Bonds will thus remain unattractive. Good news for stocks, actually. Unfortunately, valuations at current levels are challenging, as much of a V-shaped recovery is already priced in. If the Fed is right, corrections and volatility are to be expected. It is therefore important to pay attention to good quality in the portfolio. Those who have missed the recovery can use setbacks on the road to recovery as interesting entry points.