Monthly Update – May 2020

Summary

• Traditional business cycle models are still unsuitable for assessing current economic and financial market developments. The current Covid-19 crisis is based on an exogenous shock and not on long-term cyclical patterns (therefore, during this phase we refrain from presenting the usual tables for the model scores).
• We examine the relationship between the monetary and fiscal stimulus packages on the one hand and the already visible economic contraction on the other.
• Our current assessment focuses on major long-term economic risks that are difficult to assess (e.g. consumer behaviour, corporate bankruptcy or renewed virus outbreaks) and equally, on problematic financial market risks (e.g. market failure or the loss of confidence in the power of central banks). We currently consider such risks to be so significant that we are implementing a clear defensive positioning across all strategies.

Highlights and key changes

• The spread of Covid-19 is clearly beginning to slow down in many countries. We are seeing the first relaxations of restrictions imposed on the economy. In addition, hospital capacity utilisation is falling and the health system is being relieved.
• Despite this positive trend, visibility on what this means for the economy and financial markets remains extremely low.
• For example, uncertainties surrounding consumer behaviour as the economy opens up are likely to persist for the foreseeable future. It remains unclear whether the huge stimulus packages from governments and central banks will continue to have an effect beyond the short-term and whether the path back to normality will be successful.
• There are also major risks in financial markets. The collapse of the oil market with temporarily negative prices for the WTI May contract is an unprecedented warning signal and could be the harbinger of similar stress situations. Here, the ability of central banks to act is being called into question very strongly.
• The whole system is currently being kept alive with the help of unprecedented injections of liquidity, without knowing the exact consequences. In addition, political tensions arebecoming increasingly apparent, especially between China and the US, with both blaming each other over the handling of Covid-19.
• The short-term financial market indicators (yield curve, National Financial Conditions Index (NFCI), copper price, Baltic Dry Index and sentiment analysis) currently show a neutral to slightly positive outlook. However, the influence of the above-mentioned long-term uncertainties and risks currently dominate all else. For a reversal of our defensive positioning, these indicators would first have to rise significantly. Moreover, there is currently a danger that these indicators would not correctly reflect a market failure.
• We are therefore positioning ourselves defensively across our strategies and are cashing in on some of the gains achieved in the recovery over the past three weeks. As a matter of principle, we focus on high borrower quality and avoid problem sectors such as energy.
• We have reduced riskier positions in our convertible bond portfolios. We are focusing on securities with good market liquidity and especially on debtors with stable cash flows that should survive a second downswing.
• The high yield strategy remains defensively positioned. Although the market does offer a certain risk premium, there is uncertainty regarding valuations. Many borrowers cannot yet accurately assesslong-term consumption and investment behaviour. In addition, there is a benchmark shift due to the inclusion of many fallen angels that have been downgraded from the investment grade segment. Here, detailed analysis is required because many securities come from troubled sectors (energy and transport). Many high yield borrowers still have problems refinancing loans or have to offer expensive collateral.
• In our global corporate bond strategy, risky positions have also been reduced and the cash position has been increased. The various market segments must be assessed differently. For example, the ECB is currently buying EUR 1 billion worth of investment grade bonds on the market every day. This provides enormous support. In the high yield segment, however, the influence of central banks is more difficult to assess. There are also problems in many emerging markets, where less stringent Covid-19 countermeasures have been applied. In addition, emerging market central banks are taking less drastic action than in the US and Europe. High yield bonds therefore remain underweighted, both from developed and emerging markets.
• Our emerging market strategies are also defensively positioned. The focus is on downside risk and not on generating outperformance in good markets. Many emerging markets are difficult to value and there is very low visibility on the path back to normality. In addition, government and monetary aid programmes are less comprehensive than in the US and Europe. And the strong US dollar further restricts the room for manoeuvre of many central banks.We therefore focus on liquid and qualitatively sound companies.

Topics on the radar

The “Weekly Economic Index” calculated weekly by the Federal Reserve Bank of New York shows an unprecedented decline. It is far sharper than the one experienced during the major recession of 2008/09, and it is currently unclear whether the current government and monetary aid packages are sufficient to compensate for this fall. The Weekly Economic Index measures the expected change in gross domestic product based on a number of input factors, including jobless claims, estimates of petrol and diesel consumption, etc. The chart shows the period from January 2008 to today.

Chart: New York Fed Weekly Economic Index

Source: Weekly Economic Index

Please note with regards to the table of asset class preferences:
In the current fast-changing environment, we have decided not to present the usual table of country and sector preferences. Relatively static information is of limited usefulness as positioning can change quickly. Our current preference is on debtors whose credit quality is high enough to survive a prolonged recession. We also prefer securities with good market liquidity