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Coronavirus – weekly update – 13 May 2020

Blog, Coronavirus

Marina CHERNYAK
 

Cautious exits from lockdown now underway Stock markets trading sideways Major central banks prepared, if required, to do more

Worldwide COVID-19 cases crossed the 4.3 million mark and the death toll is closing in on 300,000 as of 13 May.  The focus is now increasingly shifting to monitoring new cases and fatalities in a second wave that might follow hot on the heels of exit from lockdown.

  • Those countries leading the way out of lockdown in Europe – Austria, Demark, and the Czech Republic – are yet to show any noticeable spikes in new infections (see Exhibit 1 below). As a result, their exit process continues. The data in these countries remain a key signpost and the market will no doubt be monitoring closely Germany, Italy, Spain, and France for any signs of a second wave.

Exhibit 1:

Covid-19 daily new infections in countries among the first to exit lockdown

  • The situation is more concerning in the Americas. There is a glacial decline in the number of new infections in the United States. Testifying before the US Senate health committee, Doctor Fauci, head of the US National Institute of Allergy and Infectious Diseases (NIAID), warned that reopening “could even set you back on the road to economic recovery”.  Meanwhile, Brazil leads the cumulative death toll statistics for developing nations with over 12,000 deaths (over three times more than Mexico with the second highest death toll). A recent editorial in the medical journal ‘The Lancet’ warned President Jair Bolsonaro that he “needs to drastically change course”.

R0 – the basic reproduction number – a key market signpost

With the focus now shifting to government’s capacity to manage the virus outside lockdown, we anticipate that R0 – or the basic reproduction number – will become a key market signpost. R0 describes the average number of secondary cases caused by a single infection in a population with zero acquired immunity (not to be confused with the effective reproduction number, R, which adjusts for the extent of immunity within the population).

The Robert Koch Institute now publishes a daily estimate of R0 for Germany. The latest estimate, based on electronically notified cases as of 12/05/2020, placed the reproduction number in a 95% prediction interval between 0.79 – 1.10, with a central estimate just below one.

Economic news

Hard data on the impact the lockdowns have had on economic activity are starting to arrive. We already have preliminary estimates of GDP in a number of countries for the first quarter of 2020. However, these preliminary estimates generally contain little information about economic activity in the final month of the quarter, which is precisely when the lockdowns began.

Data on industrial production and output in the manufacturing sector providing more detail are now available for March (see Exhibit 2 below). The numbers vividly illustrate the variation in the extent of the economic contraction across countries. This of course results from the differing severity of lockdown measures across countries.  Manufacturing output was essentially unchanged between February and March in Sweden, down around 5% in the UK and the USA, with falls of around 10% in Germany, almost 20% in France and around 30% in Italy.  It may well be that the level of manufacturing output falls further in the UK – closing the gap on continental Europe – in the April release when the lockdown was in full force throughout the period.

Exhibit 2:

Changes in level of manufacturing output among developed nations

Policy measures – discussions continue in Europe

Developments in Europe remain centre stage after last week’s ructions at the German Constitutional Court. In terms of a common fiscal response there is at least now clarity over the Pandemic Crisis Support tool that will be available to the sovereigns via the European Stability Mechanism. Discussions on the all-important recovery fund continue but without conclusion.

We will remain concerned about the long-term consequences of the pandemic for Europe unless and until the eurozone’s finance ministers and leaders are able to reach a consensus around a sufficiently substantial solidarity package that can create the space for all countries to do whatever it takes to support their economies.

Looking further ahead we suspect that investors will increasingly come to share the concerns of Ángel Gurría, secretary-general of the OECD, who has warned that the cost of fighting the pandemic will “come back to haunt us” given the starting position of many economies – or as he put it:

“We are going to be heavy on the wing because we are trying to fly and we were already carrying a lot of debt and now we are adding more.”

Market outlook

  • Valuations of risky asset prices remain supported by the central bank interventions and by the modest improvement in sentiment. Equities have continued to recover, albeit at a slower pace over the past few days. Credit spreads have ground slowly tighter and volatility has fallen back to levels last seen in mid-February. We see this backdrop continuing for now, with lower volatility and markets drifting sideways. This cautious positive tone is supported by the perception that any further downturn will be met by more central bank intervention or fiscal stimulus.
  • There are risks going forward, especially if the high unemployment rates consolidate at high levels with temporary layoffs becoming permanent. This, combined with current lending standards, that have tightened considerably, may hinder a sustainable rebound in asset prices. So far, financial markets have decoupled from the real economy due to central bank support. Should the economic rebound remain weak, financial markets could increasingly reflect the state of the real economy via corrections in valuations.
  • A key question is the pace of recovery in global demand. Long dated oil futures point to a recovery that may be slower than expected by equity analysts. However, China is slowly turning the corner where significant credit easing is helping the rebound. This could point the way forward for those economies that are starting to lift restrictions. One key headwind to the rebound are the current tensions between the US and China, fuelled by the upcoming US elections. There is risk of a breakdown in the existing US-China trade deal.
  • It is likely that the current stimulus programmes will have to be increased going forward as some industries (airlines, tourism, retail, etc) will require more support. This uneven recovery is pushing earnings and credit dispersion up, with entire sectors or even countries coming under significant pressure. Asset selection and risk allocation are likely to be more important than outright market calls in such an environment.
  • Emerging market assets have been hit hard by the combination of lower global trade, a stronger US dollar and increased volatility. This has created a massive rise in dispersion among emerging market credits. However, with outflows stabilising and the prospect of a weaker US dollar, some carry trades have started to look attractive, especially in Asia where the COVID-19 crisis has been better managed.

Asset allocation view

Our set of signposts remain critical orientation points as developed economies cautiously reopen.

In terms of asset allocation, we remain long market risk strategically. We overweight European and US investment-grade credit (financed by government bonds) and are long emerging market and UK equities; long commodities and long EM hard currency debt.

Having lowered our risk exposure tactically with short positions in the S&P 500 and eurozone equities, we await a market corrections to further increase our risk exposure.

Denis Panel, Chief Investment Officer Multi Assets & Quantitative Solutions, and Marina Chernyak, senior economist and coordinator of COVID-19 research.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

 The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

 Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

On the same subject:

Investments in the aforementioned fund are subject to market fluctuation and risks inherent in investing in securities. The value of investments and the revenue they generate can increase or decrease and it is possible that investors will not recover their initial investment. Source: BNP Paribas Asset Management.

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