Looking for recovery after the coronavirus sell-off
In this episode we discuss the impact of lockdowns on global growth, including employment and retail sales. We ask whether it is possible to draw any firm conclusions about the prospects for corporate earnings against this backdrop.
We also discuss the impact to investors’ income stream as companies cut dividends, discussing why they should look towards overseas income and corporate bonds as potential alternatives.
[0.26] Do markets appear to have bottomed out, there has been a notable recovery in the past weeks?
- after falling 34% from their peak this year, global equities (as measured by the MSCI All Country World Index) bottomed-out on 23 March
- they have since rallied 25%1 at the time of writing
- stocks were bought on signs that the coronavirus outbreak may be peaking after a slowing in daily new cases in epicentres like Italy and New York
- equities were also lifted after the Fed (and other central banks) stepped-up their asset purchases (Quantitative Easing) and governments around the world unveiled record stimulus programs.
[1.18] Is it primarily the fiscal and monetary stimulus that’s driven this recovery?
- Crucially, governments and central banks are working together to ensure funding flows to the private sector during the lockdown
- For example, the $2.3trn US Coronavirus, Aid, Relief, and Economic Security Act (the ’CARES’ Act,) stimulus package includes unprecedented US Treasury-Federal Reserve co-operation
- the US Treasury will allocate $454bn to the Fed who can multiply this capital by up to 10 times to provide credit worth around $4.5trn for firms, municipalities and funding support for the corporate bond market2
- this ‘state capitalism’ of injecting money into the economy, has ensured there is ample liquidity flowing through the financial system
- US broad M2 money supply (e.g. currency in circulation and bank deposits), a rough proxy of the stock of money in the financial system, is expanding by over 18% a year1, the fastest pace since the second World War
- the hope is that this largesse also helps support other credit markets too
[2.45] What’s your view on the picture for global growth?
- despite the improving funding environment, the underlying picture for global growth looks gloomy, for example, China, the first major economy to release output data, saw its real GDP contract 6.8% in the first quarter, its biggest decline on record from over 30 years of available data1
- for the 2020 calendar year, the IMF’s latest economic projections see a -3% decline in global GDP, its worst performance since the Great Depression3 more than 90 years ago
- GDP contractions have led analysts to revise down global Earnings Per Share to -12% for 2020 so far1
[5.25] Turning to financial markets, what do you think it will take for the rally to endure?
- if equities are going to rally over the longer term, there needs to be a fundamental improvement in growth, for that to happen governments need to ease back on lockdowns
- encouragingly, this is starting to happen. In Germany, small shops and car dealerships (an important industry for the country) resumed business from 20 April, while schools for older children are due to reopen on 3 May
- according to a Sunday Times report, the UK government may partially open-up the economy in staggered phases from 11 May
- President Trump, with an eye to the upcoming election in November, is upping the pressure on state governors to loosen up on the lockdown. A V-shaped economic recovery will only be possible if restrictions are lifted and soon - the risk for markets is that a second coronavirus outbreak prevents governments from opening-up their respective economies.
[6.39] What are the more pressing risks in the short-term?
- the most immediate risk is to what extent government lockdowns from COVID-19 will impact labour markets, domestic demand growth and debt defaults
- US initial jobless claims (an early read of the unemployment rate) have risen by a staggering 26m cumulatively over the past 5 weeks1
- higher unemployment is already leading to lower domestic demand. For example, retail sales fell by 8.7% in March, the biggest decline on record from data going back to the early 1990s1
- less demand is likely to lead to rising private-sector debt default rates, which instils uncertainty in financial markets
- however, the Fed’s explicit backstop of the US corporate credit market enabled investment grade rated companies to issue a record $264bn in bonds in March, breaking the prior record in January 2017 by over $80bn4
- given that major corporations continue to have access to capital markets, the risk of a credit event, like the collapse of Lehman’s during the Global Financial Crisis in 2008, has been somewhat reduced - Our base case is that policy support will drive equities higher over the next 12 months
[8.38] Companies have been cutting dividends, to what extent does this present a problem for investors?
- as the ramifications of the global lockdown response to COVID-19 develop, corporate boards are cutting dividends in response to commercial and regulatory pressure - some industries, such as airlines, face an unprecedented zero-level of business, until more normal life resumes
- The impact on company earnings (and therefore dividends) is dependent upon how long the lockdowns continue and how long the recovery takes, which remains unknown
- UK payouts look particularly precarious, as its dividend cover is low relative to other major markets and is subject to idiosyncratic sector risks; regulators have told UK banks to cancel their 2020 dividends to retain capital
- cuts to dividends in the equity market serve as a reminder of the benefits of diversification in a multi-asset portfolio - income investors need to look beyond UK financials, and towards overseas markets
- while government bonds look expensive on a historic basis, the security of their coupon (and principal) payments is reliable
- it is difficult to generalise across differing mandates, but we would expect income to be reduced by around 20% on a typical multi-asset portfolio
1 Refinitiv Datastream, 30 April 2020
2 JPMorgan, 3 April 2020
3 IMF, 20 April 2020
4 Morgan Stanley, 30 April 2020 ***
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This episode was recorded on 30/04/2020
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The Pulse from Smith & Williamson
Investment Show: Looking for recovery after the coronavirus sell-off
Broadcast on Smith & Williamson at 09:00, 30th of APRIL 2020
Available online from 10:00 on the same day .