Financial Markets Flash - 15 April 2020 -
Time to prepare for a “post-coronavirus” world?
Deputy Chief Executive Officer,
Chief Investment Officer
We expect some key themes to emerge in the “post-coronavirus” world…
There is still rather little visibility on how and when this crisis is going to end, which is keeping volatility high. As in any major crisis, there are and will be investment opportunities to seize; and we also wonder about what will happen after the dust settles. Emotions often run high during tough times, sometimes leading to overreaction. We would advise caution here: how often have we heard people say “it’ll be different this time around”? Nonetheless, we do expect some key themes to emerge in the “post-coronavirus” world…
The markets are currently moving impressively fast: the S&P 500 (the benchmark index for US equities) has just had its best week in close to 45 years and jumped by +12%. This follows an initial drop of around -35% in less than 5 weeks. So US stocks have regained about +25% since bottoming out in March and have therefore wiped out half of their initial losses. European stocks have followed almost exactly the same trajectory.
We have already given our analysis of the situation. The markets have moved so abruptly because investors were initially left bewildered by the sudden suspension of economic activity as whole populations were locked down; they then bounced back thanks to the speed and scale of the measures taken by the world’s central banks and governments.
We believe the next phase will be rather more uncertain and less linear in the short term, and that now is the time to think about what is going to happen once the crisis ends.
Short term, the markets will move in step with macroeconomic and microeconomic newsflow which is now coming in thick and fast. Economic statistics are looking more and more overwhelming each day: GDP in large developed economies is now seen contracting by between 5% and 10%. On the other hand, there is no consensus on the shape of the market recovery: will it be a “V”, “U”, “L”…? Strategists have increasingly diverging views on the matter, which is likely to lead to more market turbulence. US bank Goldman Sachs, for instance, has just revised its scenario and now thinks the markets have already bottomed out. It expects the S&P 500 index to reach 3,000 points by the end of the year thanks to lower interest rates and stimulus plans which are going to boost economies now that the epidemic is close to peaking. Others, however, believe that the crisis will have a lasting and severe impact, and that its consequences for corporate earnings have not yet been fully factored in. The reporting season is going to kick off in the USA this week. It will be interesting to hear what CEOs have to say about the outlook (if they say anything about it at all!). Our view is that corporate earnings are going to be hit very hard indeed, which is why we have a cautious stance and “neutral” rating on equities for the short term. In a recession on this scale, we believe overall earnings could drop by 30% to 40% but, more importantly, we have little visibility on the outlook for 2021 and on the prospect of earnings returning to “normal”. If we assume normality is restored quite quickly, then the PER (Price to Earnings Ratio. A stock market analysis indicator: market capitalisation divided by net income) would be 16 for US stocks and 13 for European stocks, which is not a given considering this assumption is so arbitrary, especially as dividends are generally going to be halved this year. We reckon the best option for the short term is to make the most of the lack of liquidity by investing in Investment Grade and High Yield bonds that have been heavily penalised by recent market conditions and that offer attractive yields.
Longer term, we believe now is a good time to begin thinking about what is going to happen after the crisis. This episode has revealed a certain number of failings in Western countries, which will inevitably trigger action and change. However, we are not among those clamouring for everything to be called into question. Globalisation has created a more prosperous world over the last 30 years or so, and also a relatively peaceful one (compared with previous periods); and it has enabled much of the world’s population to escape poverty. We therefore urge caution when we hear talk about reviving the concepts of nationalisation, centralized planning, etc.
On a pragmatic note, the fact is that this pandemic has taken a very heavy economic toll.
This will therefore lead to more behavioural changes among governments, consumers and businesses alike.
The vast majority of governments have abandoned all talk of orthodox budget policies, and probably for quite some time. This is the case in the USA, but then the country does have the privilege of being able to refinance itself in the world’s biggest international reserve currency. The eurozone, meanwhile, is showing signs of Japanisation with an ageing population and growing debt being bought up by its central bank. But an ideological gap is widening somewhat between Northern and Southern European countries. Although Europe has agreed on a general fiscal stimulus package, this gap is far from closing and it will probably become an issue again once the epidemic has eased. So the markets are bound to put the strength of the eurozone to the test yet again, especially if certain eurozone countries see their credit ratings downgraded further by the rating agencies. In the meantime, questions are being asked about the sense and limitations of the ECB’s sovereign bond buying spree: how much can a currency be worth if it is based on heavily indebted countries? Why not consider handing the population some sort of universal basic income? With all countries now adopting similar deficit policies, exchange rates are relatively stable; but might it not make more sense to invest in physical assets, such as gold?
As far as consumers and businesses are concerned, investors have already taken note of a certain number of themes that are going to emerge or become even more prominent.
Relocation is one such theme. This had already begun with the trade war. Today’s crisis has shown that our economies are too heavily dependent on international subcontractors. So the matter will be debated with respect to the main issues relating to each country’s national security: the healthcare sector, of course, and food supplies, but also energy and potentially defence…
Another major beneficiary of this crisis is the “online” world. Grid infrastructure, cybersecurity, communication systems for remote working and videoconferencing, the development of 5G... All are going to ramp up as remote working will probably become more widespread. On the other hand, commercial real estate could take a hit as service industries reorganise the way they work.
The ESG theme (Environment, Social, Governance) will also emerge from this crisis on a stronger footing. ESG was already beginning to show just how relevant it is, but those companies that have proved most virtuous in today’s difficult circumstances will now be more sought-after by investors.
These are the main themes that might emerge, and there are many others besides. Over the coming weeks, we will have to see to what extent investment opportunities might arise and with what consequences, while bearing in mind that these potential transformations are going to take place over quite a long period of time.
Document completed on 15/04/2020.