Our projections indicate that the shock to world economic activity and prices due to the coronavirus Covid-19 has been profound, and that the global cycle downswing will deepen into June 2020.
Unprecedented monetary and fiscal policy interventions provided interim support for risk asset valuations after the initial selloff, in the run-up to further information on potential medicines, seasonality, and vaccines. Valuations for world equities are at 2008-2009 lows, and higher valuations will depend upon how fast a phased return to work progresses worldwide. Equity markets are more likely to show a V-shaped recovery, if given new, positive information and further monetary and fiscal support, than is the global economy, in light of the deteriorating output projections for the coming quarter. Sovereign bond yields probably will remain at the record lows set by their respective central banks.
The principal question for risk assets, with nearly all equity markets at very inexpensive levels and global authorities intervening without evident limits, is whether positive evolutions for efforts to accelerate the global return to work will materialise sooner than expected. These would be effective medicines or prophylactics against infections, reliable antibody tests that identify those who are no longer at risk and able to return to work, and reduced development times for vaccines that prevent subsequent outbreaks. Given the balance of risks at current very low equity market valuations, investors may do well to hold portfolios balanced between positions in large capitalisation shares and in sovereign bonds.
A global phased return to work
It seems likely that, following China, the US and Europe will move towards a phased return to work, whilst also taking aggressive protective measures against Covid-19.
The following five protective measures seem to us to be most likely: rigorous testing, including for those without symptoms; antibody tests to identify those who have recovered, and who therefore no longer pose a risk and can return to work; aggressive contact tracing of those found to have the virus; ongoing quarantine for those who are vulnerable or infected; and more widespread wearing of masks and gloves.
Events are possible that could accelerate a phased return to work. For example, one or more of the four medicines identified by the World Health Organization (WHO), and now under trial, could prove to be curative or prophylactic. It is also possible that one or more of the antibody tests – currently under evaluation – to identify those who have recovered from the virus could prove to be effective. Already, 3.5 million have been ordered by the UK government. Infections may turn out to be highly seasonal and peak over the next two weeks in the northern hemisphere. Any of these events would accelerate the return to work.
Monetary policy and fiscal support
The US Federal Reserve has moved very quickly to apply the lessons it learned in 2008. Liquidity in the US$ trillions is available to banks, commercial paper markets, money markets, primary dealers, and the world’s major central banks. The US Federal Reserve’s fixed income purchases are unlimited, as it adopts the ‘whatever it takes’ approach. US Fed funds, 10 year yields, and 30 year yields have been set to 0%, less than 1% and less than 1.5%. US fiscal stimulus is at US$2.2 trillion, with more to come.
Equity market and bond market impacts from here
There is an asymmetry for equities, with more potential good surprises than bad, in our view.
The stock market is more likely to recover in a V shape than the economy, which will show a U at best. US and other equity market valuations are at their 2008 lows, and appear to have ‘priced in’ the lockdowns to last at least a month, and with a phased activity restart taking several months thereafter. Monetary and fiscal policy interventions likely will support equity and bond markets from here, while investors receive information reflecting medicine trials, seasonality, and vaccines.
Improvements in equity valuations will depend principally upon how fast the phased return to work can progress. The stock market is less likely to reflect the ‘shutdown’ economy as time passes and the authorities intervene, while the bond market will be guided by the US Federal Reserve’s interventions.
Outlook for Q2 2020
World sovereign bond markets, again showing record low yields, accurately reflect the shift down in world output and inflation that appears as a suddenly renewed continuation of the global downtrend from 2018. Equity markets may be more independent of the economic cycle downturn, as it was induced by an external pandemic shock, and as the supportive response from central banks and fiscal authorities has been unprecedented. When equity valuations fell to their 2008-2009 lows, the trigger then was a housing, financial system and credit crisis that would take years to correct. Low current risk-asset valuations are on a par with those decade old levels, even though the US economy until one month ago showed record output, employment, and wage growth. The key to equity performance in Q2 2020 will be whether current expectations as to ‘remain at home’ restrictions on the global economy will be exceeded or will be shortened. Low share valuations suggest that positive results from any of the medicine, antibody, or vaccine trials would be upside surprises, and that the effectiveness of unheard-of monetary and fiscal policy interventions has been only partially discounted in the equity markets. Investors may do well to hold portfolios balanced between shares and sovereign bonds in Q2 2020.