What a difference a month makes. Or more aptly put by Lenin, “There are decades where nothing happens and there are weeks where decades happen”. Last month’s issue was written on the cusp of the death of the longest bull market in history that started in March 2009. Since then, the U.S. S&P 500 fell nearly 34% from the recent peak made on 20 February 2020 to the recent trough made on 24 March 2020, then proceeded to rally into a bull market that is currently up 25% from the bottom, or 17% down from 20 February 2020 at the time of writing.
The S&P/ASX 200 followed closely, bottoming on 23 March 2020 after losing 36.5% from the February highs, and rebounding 21.5% to date. It is now 23% below the February high. The Euro Stoxx 50 had it worse on the drawdown, falling over 38% before rebounding 18% to date, leaving it down 27%.
Meanwhile, China and Hong Kong followed a slightly different path. The CSI 300 had already fallen over 10% between late January and early February as the COVID-19 outbreak began. It rebounded to new highs by early March, before following global markets lower as COVID-19 spread globally, but avoided a bear market, falling 16% at the nadir and is less than 10% down from the March high.
Unlike equities, oil has seen little respite, despite an agreement between many of the largest oil producing nations agreeing to a historic cut as the collapse in demand and concerns around adherence to production restrictions weighed heavily. As a result, Brent crude prices remain below U.S. $30 dollars per barrel. Copper, often a proxy for economic growth, also remains weak. Meanwhile, gold continues to benefit from safe-haven demand, up over 12% in the past four weeks to over U.S. $1,700 per ounce.
Safe haven bonds were not spared from the volatility and sold-off in late March as a liquidity squeeze forced investors to sell even the most defensive government bonds to cover margin calls or provide cash flow. Since then, many central banks globally have stepped up monetary support via new and more wide-ranging quantitative easing programs, among other measures. This led to government yields pushing lower once again in the early weeks of April. Corporate bonds including investment grade followed a similar path, though the sell-down was more pronounced given the higher expected risk of defaults in a recession, but have since rebounded strongly.
The Australian Dollar was not spared from the volatility as it fell to 55 U.S. cents before rebounding and is currently sitting around 63.5 U.S. cents.
Most major economies are in lockdown which has resulted in a severe contraction in economic activity and most countries will definitely see a recession. Given the circumstances, markets are giving less weight to incoming data on the economy and are focusing on trying to gauge the progress of containing the epidemic and what happens next; meaning that markets are more focused on speculating when and how the lockdowns will end, and how fast can activity rebound. Unlike a normal recession where manufacturing has historically been the primary driver, this recession will be driven by the service sector. For most economies, data prior to March has lost relevance.
Australian employment figures have held up well in March, defying consensus expectations for a 40,000 fall. Instead, employment rose by 5,900 with full-time employment falling by 400, more than offset by a rise in part-time employment. As such, the unemployment rate held was at 5.2%. On the negative side, consumer and business sentiment readings both fell off a cliff.
Unlike Australian figures, employment in the U.S. fell by more than expected in March, prior to when most states started to restrict activity. Jobs fell by 701,000 and the unemployment rate rose to 4.4% but with unemployment claims rising by almost 22 million over the past few weeks, the unemployment rate will be spiking much higher in the April reading. Economic indicators for March showed a steep drop in service activity as well, whilst manufacturing contracted as well, albeit at a much more moderate pace. Again, both are likely to be worse in April as the rest of America followed the first few into lockdown.
Chinese data may offer some insight into a post-COVID-19 economy given that it is about a month ahead in terms of COVID-19 timeline and has come out of domestic lockdown. Both services and manufacturing indicators bounced back into growth territory in March which is encouraging, however, these indicators provide a guide for the direction and not the magnitude of recovery. China’s Gross Domestic Product (GDP) fell 9.8% in the first quarter showing the impact of lockdown is nothing to be scoffed at, especially since the service sector is a much smaller part of China’s economy relative to the U.S. or Australia. Industrial production fell 1.1% year on year in March, whilst retail sales fell 15.8% giving further insights as to the contrasting impacts of a lockdown on different segments of the economy.
The length of lockdowns in various countries and the impact on the global economy remains anyone’s guess at this stage. News has been incrementally positive over the past weeks, hence markets have rallied, but it is still too early to assume that re-opening of economies, currently targeted to start in May for most countries, will not be delayed.
Stimulus in the time of COVID-19
Last month’s edition covered how COVID-19 was not only a health crisis for people, but a health crisis for businesses as well. Whilst viable treatments for people are still being tested, treatment for the economy via monetary and fiscal stimulus has been swift and strong. Monetary stimulus includes renewed and expanded quantitative programs.
Domestically, the Reserve Bank of Australia (RBA) has cut rates twice to 0.25% and announced a quantitative easing (QE) program to target 3-year government bond yields at 0.25% with no limit to the amounts it can purchase. Meanwhile, the government has put in place three stimulus packages worth nearly 10% of a year’s GDP with measures including income support for people and cash flow support to businesses.
In the U.S., the Federal Reserve (Fed) cut rates by 1.5% to 0-0.25% in March, following by a hugely expanded QE program which now has the ability to buy non-investment grade bonds that meet a certain criteria. Furthermore, the Fed has established direct swap lines with multiple other central banks to provide liquidity to the currency market to ensure U.S. Dollar liquidity. The U.S. government also pledged a stimulus package of over 11% of GDP (approximately 2.3 trillion U.S. Dollar) in stimulus to support both people and businesses with more likely to be announced in the coming days as further packages are being discussed.
Large stimulus packages are now widespread, with some notable ones being Japan’s fiscal stimulus of up to 20% of GDP, Canada at 8.4%. Never has there been such large swathes of money being pumped through by governments without a major war. Even so, more treatment may be needed for the ailing global economy if lockdowns continue. Fortunately, at the time of writing, there has been some optimism in Europe and the U.S. as the number of new cases have slowed and governments are starting to plan for a gradual end to the lockdown.
Life after lockdown
Markets and governments seem in agreement that the situation has improved enough for lockdowns to be eased in the coming month. Unfortunately, a return to full normality will likely take a much longer time for most countries, potentially well over a year, and is dependent on a vaccine. Instead, one can expect a gradual easing of restrictions over time.
The easing of restrictions will come in different forms for different countries but will likely follow a similar shape. First will come reopening of select business sectors that are of high importance and where the number of people are limited such as businesses involved in manufacturing. Then will come the offices and potentially services in a restricted manner. Restaurants may have to put tables at a certain distance and may need to record your identities for potential contact tracing purposes. Large scale events such as religious gatherings, concerts or festivals may remain banned until a vaccine is developed.
Even after restrictions are lifted, people may be cautious and spend less time out of home, as seen in Beijing, where weekend traffic remains well below the 2019 average, despite Beijing having seen a limited outbreak.
Source: TomTom.com live traffic data
Again, these will differ between countries based on their ability to control the outbreak and the trust of their citizens in the ability to do so. The hope is that there are more examples like Korea, a country with the second most cases early in the global outbreak. On the weekend, cafes, parks and stores were crowded in Seoul, as the country’s strategy of mass testing quickly controlled the outbreak. However, the risk there is that it results in a second wave of infections.
At this stage, the sharp recovery since late March is pricing in an optimistic outcome, as global daily new cases look to be falling, governments planning for the easing of movement restrictions and reports of trial treatments having positive results spur sentiment. Investors should be cautious rushing in as it is unlikely to be a straight road, with potential for mistakes by governments in easing restrictions too early resulting in a second wave of infections that forces a return to lockdown.
Furthermore, there will be longer term impacts on consumer behaviour and certain industries. For example, digital trends are likely to accelerate as video conferencing and e-commerce become more normal, with the side-effect being business travel and physical retail among the first order effects, but second order effects may be that rentals fall and logistics providers benefit. Investors have to be mindful not to buy into businesses that may never recover as some of these long-term shifts may not be easily identified early on.
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