Monthly Update – April 2020


Summary

• Our current market assessment has been based on our analysis of the monetary and fiscal stimulus packages offered. More specifically, we have focused on the relationship these stimulus packages have had on the current valuations seen in equity and credit markets.
• Furthermore, we have included analysis on how the Covid-19 virus has spread.
• The current crisis was caused by an exogenous shock and is not the result of systemic factors, misallocations or structural weaknesses in the global economy. Our macro model therefore, does not currently provide any utilisable signals because it does not capture exogenous shocks.
• Our main expected scenario continues to be a "U-shaped recovery", i.e. after a certain period of bottoming out, the global economy and stock markets are expected to recover later this year.
• The actual course and extent of this recovery will depend on the effectiveness of the stimulus packages in relation to the spread of Covid-19.

Highlights and key changes

• The aid packages provided by governments and central banks are now in the region of 10 to 15 percent of annual GDP. This covers a shutdown period of two to three months.
• If it becomes apparent that these shutdowns will be eased earlier, then a rapid and strong recovery can be expected. This is because we have already seen massive injections of liquidity, and if this positive scenario plays out, there will be a lot of energy in the system.
• However, the current main danger comes from the US. Here, the Covid-19 countermeasures have been introduced at a later stage. Therefore, in contrast to Europe and Asia, it is too early to precisely forecast the developments in the US.
• If the outbreak escalates in the US, further major market unrest should be expected worldwide. In this scenario, it is not only the real consequences that are dangerous, but also the negative mindsets of market participants, which can lead to self-fulfilling negative projections.
• Stock markets worldwide have currently priced in around two months of shutdown. Accordingly, deviations from this timeline will lead to corresponding upward or downward moves. In the long term, even if the pandemic develops favourably, longer-lasting structural damage can be expected, at least in some sectors.
• Investment grade (IG) and high yield (HY) bonds should be looked at separately. The purchases of IG corporate bonds announced by the US Federal Reserve on Monday (23 March) provide a more positive outlook and increases market liquidity. At first glance, the estimated corporate bond purchase volume of USD 200 billion appears moderate in comparison to the size of the USD IG credit market (equivalent to 2.5% of the USD IG market). However, we assume that the announced programme is only the beginning. It is likely we will receive significantly more firepower as part of the major stimulus package passed by the US Senate on Wednesday (25 March).
• In Europe, we prefer investment grade bonds to high yield bonds due to ECB purchases (where we rate IG as neutral and HY as negative). Although the high yield segment is optically now favourably valued, further declines in price are still quite possible. Market liquidity is also extremely low.
• Governments’ aid programmes for credit markets partly include high yield rated companies. However, it is not yet clear at present whether the amounts are sufficient.
• In emerging markets, alongside existing fiscal and monetary support, there exists the potential for ongoing and greater government involvement in certain sectors and credits. Albeit, this is less likely to occur directly through financial markets.
• We are also monitoring possible differences between sectors and countries. It is conceivable that service-oriented economies (such as the US) will suffer more than countries with a high manufacturing output. Initial Purchasing Managers surveys (PMI) point in this direction.
• Sectorwise, energy and transport, as well as aviation and leisure industries remain problematic and very challenging. This is especially true in the high yield segment. Even at low prices, there have been no buy signals yet. In order for the situation in the energy sector to improve, oil prices should reach at least USD 35 per barrel and then move relatively quickly towards USD 50 per barrel.
• A certain degree of calming can be seen in metals. We may be in the process of reaching the bottom here, as long as the epidemic continues on its current trajectory.
• The banking sector is likely to remain under pressure. Lower interest rates and the slump in investment banking activity are weighing on profitability. In addition, high write-downs are likely to be necessary as the credit quality of debtors will suffer. However, we believe that the potential for losses is greater for bank equities rather than bank bonds. The reason is that some banks are supporting their creditworthiness by cutting dividends, and regulators are considering, or in some cases have already announced, a relaxation of credit provisioning and equity ratios.
• In the convertible bond segment, convertibles are in particular demand from companies with strong balance sheets (high cash, low debt and stable cash flows). This is true for all sectors mentioned below (see the table below for our preferred sectors and countries).
• Foreign exchange markets are supported globally by measures taken by the Fed to increase US dollar liquidity. An excessively strong dollar would cause additional difficulties for various emerging markets.
  

Topics on the radar

After the slowdown in China and South Korea, the spread of Covid-19 is now beginning to decrease slightly in Italy, which has so far been the most severely affected country. The speed of new infections is declining. As the following graph shows, Italy is now approaching the curve of China. However, the US remains a black box for the time being. Here, the reported figures are not yet meaningful for the time being, as extensive testing is only now slowly getting underway.

Chart:
Confirmed cases of Covid-19 for selected countries

Showing the number of cases since the day of the 100th case, using a log scale.