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The following global market commentary is contributed by David Lafferty, Senior Vice President and Chief Investment Strategist at Natixis Investment Managers.
Outbreak & Macro
- The duration of the outbreak remains the key variable in determining the extent of the economic damage, and this variable is still largely unknown.
- In the US, more rapid deployment of testing kits means cases will rise dramatically, and with it, the reality that the slowdown will last longer. The news from Italy last week was unrelentingly bleak.
- We saw at least two significant markers last week – both negative. The first was a deeper lockdown across California, New York, and Illinois. The second was the emergence of some evidence that the virus could be more dangerous to younger populations than previously thought. If true, that’s a game-changer – and not in a good way.
- When I model the impact on growth and GDP, the range is astonishingly wide. Everyone is modelling a sharp and deep slowdown, but assumptions about the duration of the outbreak, the shape of the recovery, and the success of the policy response have an enormous impact. With just a few tweaks here or there, your growth outlook can swing from ‘mild recession’ to ‘severe depression.’
- The biggest swing variable for US GDP is the service economy: How much of it as actually shut down and for how long?
- Q2 US GDP looks like it will be down high single-digits or low double digits. (-7% to -12% SAAR). That looks about right, but Q1 estimates are probably too high and forecasts for the second half recovery are too optimistic. I expect the recovery to be a bit softer than most, more ‘U’ and less ‘V.’
Policy Response
- The major central banks have largely done their jobs. Taking rates to 0% and printing money until the ink runs dry was the easy part. The hard part is providing access to funds – keeping banks and their customers liquid.
- On this score, it’s been encouraging to see monetary policymakers dusting off the playbook of liquidity programs from 2008 - 2012. [The GFC and European Banking Crisis]. Central bankers have provided an ocean-sized punchbowl. Now the question is, will anyone drink from it?
- This week, the fiscal response kicked into high gear. In the US, scrapping the payroll tax break in favour of more direct payments is a big improvement. Given the short run trajectory of the virus (3-6 months?), bridging the spring/summer cash-flow gap for firms and employees is paramount. It looks like even the ultra-polarized US Congress is about to unleash fiscal ‘shock and awe.’ We still don’t know if it will be enough or how quickly it will be dispersed. It sounds easy in theory, but how do you get cash in the hands of consumers and businesses in practice?
- As we monitor the monetary and fiscal response, it is important to remember that regardless of their efficacy, these policies will not be boosting economic growth, they’ll simply be mitigating economic losses. The government can ‘help’, but they can’t ‘fix.’ Only the medical response can do that.
- Soon after the virus has run its course, the public policy examination will begin. Bailouts are coming and they will have conditions. The outbreak is going to renew a massive regulatory debate. Bailouts, buybacks, and bonuses - moral hazard will be back in the spotlight.
Yields, Bonds, and Liquidity
- In the short run, massive QE and liquidity injections have settled US Treasury yields back down. However, at 0.85%, the 10-year Treasury is pricing recessionary activity levels for years. That’s too pessimistic. Longer-term, equilibrium rates are far too low – both real yields and inflation premiums.
- Current global bond yields imply returns for the next 4-5 years between 1.5% - 2.5%. This simply won’t get it done for most retirees or institutional investors, so after the pandemic, the push back into stocks will continue. This may start slow, but will accelerate as risk aversion – the sting of recent losses – fades.
- Similar to stocks (see below), the carnage in the credit markets has been severe. However, with little sense of the liquidity needs and who will or won’t get bailed out, this is still a bond picker’s market.
- The rush to safety means selling anything liquid, regardless of quality. Undoubtedly, there are some good credits that are getting taken to the woodshed.
Equities
- VIX remains extremely elevated but has come down from nosebleed levels in the last few days. This hints that there is some additional pain to come, but that the worst downside equity moves may have already happened.
- The sentiment is negative but far from washout levels.
- For the S&P 500, our estimate of the drop in earnings combined with P/E compression forecasts a drawdown of -35% to -50%, a very wide range to be sure. Since the February 19 peak, the index is already down -32%
- In the near term, investors should expect a bit more downside, but market timing is impossible, and we’re quickly approaching valuations that look interesting. If you can stomach the volatility, you can start nibbling back at risky assets.
- This is subject to revision. If the pandemic isn’t under control by May/June, our full-year earnings estimates are too optimistic. Translation: Our S&P 500 drawdown forecast is too rosy.
- I’m no fan of the CAPE ratio, but we’re entering a period where investors will start to look through the cycle. At some point, equity prices are going to discount what earnings look like after coronavirus, not during the pandemic.
- The speed of the losses and the temporary nature of the pandemic means the market’s reversal could be quick. This could be a very easy rebound to miss. Instead of guessing the bottom, better to get back in a bit early than a bit late.
