The scale of the global policy response to the COVID-19 crisis has been a pleasant surprise, yet the focus will now shift to its efficacy, given delays and logistical bottlenecks in building newly formed income bridges. We expect a muted recovery path as fears of a second wave of infections limit the return of workers, and thus the snapback in demand. From a global multi-asset perspective, we have progressively de-risked since February, and are now nudging our risk up slightly, but to a still cautious level.
The lockdowns to contain the coronavirus outbreak are just beginning to inflict severe near-term economic damage, and these sudden stoppages have the potential to cause longer-lasting damage as well. Here are some of our key concerns:
Efficacy Of Response
First, although the scale of policy responses – both fiscal and monetary – has been impressive, the focus now turns toward their efficacy.
Most small businesses are unable to cope with even short periods of negative cash flow. Unfortunately, despite swift and sweeping legislation, implementation realities are likely to delay getting cash into the hands of business owners in time to avoid the damage of layoffs and bankruptcies. While we are confident that the response will be sufficient to avoid a cascading balance sheet financial crisis, we think it may not go far enough to prevent a deep recession with severely negative consequences for corporate cash flows. Thereafter, the frictions involved in restarting entire economies may prove more arduous than many seem to anticipate.
Path Of Recovery
Second, as we envisage the path to recovery, we are looking to Asia given that while its fundamentals are improving as others begin to plunge, what we see is still not particularly encouraging.
The complex process of coordinating the restart of an economy after a sudden stop is not graceful in the best of times. This time it is compounded by fears of a second wave of infections, which appear to us almost inevitable until a vaccine is found and produced in quantity. That is likely at least 18 months away. Meanwhile, a second county in China – Jia, in Henan Province – was just locked down under quarantine weeks after Hubei was partially reopened. While Jia is much smaller, the move highlights how difficult it will be to totally stamp this out. The result is a slow pace in the return of workers and substantial inefficiencies once they are back.
Thirdly, research indicates a clear link between pandemics and a subsequent rise in precautionary savings.
This would add to the existing savings glut and present yet another drag on global growth after a return to work. Most crises also see policy that first aims to put out the fire, but then turns to reducing the risk for repeats, which often inadvertently limits the upside as well.
We expect markets to progressively price in a sharper and longer-lasting hit to cash flows.
Asset Class Views
At PineBridge, we look for opportunities across more than 80 asset classes to find the most attractive ones over an intermediate period. Our focus is to balance the need to protect portfolios against downside risk with the need to remain flexible and open to adding risk when attractive opportunities present themselves. Here, we set out our intermediate-term convictions across major asset classes, along with the trends and developments that could have an impact on our positioning going forward.
We maintain an underweight position, with a tilt toward Asian markets – in particular, China A-shares are looking most attractive. Fundamentals are already rising, and we anticipate further stimulus from China, leaning toward “new infrastructure,” with a greater state-led push for 5G, semiconductors, and fortification of the healthcare system. Concurrently, we are evaluating a range of themes where we see secular growth potential once the recovery has begun, in areas where valuations have removed last year’s parabolic price moves. Examples include renewable energy, mobile payments, and homebuilders.
Credit is rising in the ranks of the most attractively valued asset classes. This contrasts with the last few years, when spreads were very tight, offering capped upside potential, and with deteriorating fundamentals to boot. Now, spreads are pricing in a severe recession, including an imminent default wave (and then some), providing an opportunity to potentially achieve equity-like returns. US investment-grade, in particular, looks very attractive due to rarely witnessed spread levels as well as spread duration, supported by direct buying by the Federal Reserve. Federally assisted lending to ensure that chosen industries have enough liquidity will also diminish the imminent default wave a bit.
In Credit Markets, Investment Grade Valuations Have Rarely Been Cheaper
US AA and BBB ex-financials OAS
Sources: Macrobond, Bloomberg, PineBridge Investments calculations as of 2 March 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Oil markets remain dislocated and unanchored. While headlines portray a price war between Russia and Saudi Arabia, we attribute most of the price drop to plummeting oil demand amid global lockdowns. These producers are actually acting rationally to maximize market share in an environment where no level of realistic supply cuts would offset the scale demand loss. Even with a “truce,” we would expect limited scope for oil price appreciation without substantial demand recovery.
The coronavirus pandemic will undoubtedly leave an impact on economies, societies, and markets. Once coronavirus infection rates peak and we can see a time frame for lifting containment measures, it will be easier to focus on the shape and pace of recovery. Navigate markets with the help of our coronavirus-related coverage: https://www.pinebridge.com/insights/coronavirus-in-context
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Last updated 31 March 2020.