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March 27, 2020

Coronavirus: Focus shifts to the US

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Coronavirus: Focus shifts to the US

March 27, 2020

In our note last week, we highlighted the efforts central banks and governments globally are taking to support the economy. The monetary and fiscal stimulus that we are seeing is clearly positive, yet we now find ourselves at an inflection point. If we are to see a turnaround, global co-ordination in healthcare is crucial, but this is not yet happening. Whilst Asia has largely managed to contain COVID-19 and is starting to recover, the focus has now shifted to Europe and the US, where many countries are still in the escalation phase. A positive sign would be if we see the number of new cases of infection peaking in Europe and the US.

However, the US is clearly now becoming the epicenter of this pandemic. The number of cases in the US is still growing rapidly, with limited credible action being taken at the Federal level, as President Trump prefers to focus on restarting the economy by Easter. In contrast, the most decisive actions, such as restrictions on movement, are being taken at the state or municipal level. Despite other countries such as South Korea demonstrating the effectiveness of testing, in the US this is also not yet at the scale required. Most concerning is that in many parts of the US there still appears to be denial of the virus’ severity and impact. We believe that until credible steps are taken to contain the virus in the US, the country will be unable to begin its path to recovery, impacting global economic recovery.

US fiscal stimulus: speed is of the essence

Providing a financial solution to a medical problem will not work. The economy cannot fully benefit from the fiscal and monetary stimulus if it is “closed down” by the virus. The real solution is to contain the virus, with the tools currently available such as “social distancing”. However, the priority must be to provide the healthcare system with critical equipment such as respirators and moving medical personnel to places that really need them. This is the only way that the ultimate economic disruption caused by the virus can be minimised. Monetary stimulus can ease the pain and fiscal stimulus can reboot an economy that has been disrupted, but it does not stop the disruption and cannot bring everything back to normal.

We are likely to see growing pressure on businesses, which cannot function normally. Whilst the US Congress is soon likely to pass an unprecedented $2tn stimulus package (almost 10% of US GDP¹), a key question is how quickly this will be deployed. Also key is how much will be translated into real spending, which could net off some of the decline in GDP expected this year. We are concerned that bankruptcies are likely to increase for small and medium sized companies, which employ most people in the US and are therefore a significant driver of economic growth. On average small businesses in the US have a 27-day cash buffer², but for many it is much less. 25% of small companies have less than 13 days’ cash buffer. Therefore, speed is of the essence as the damage to these businesses is likely to happen quickly. The stimulus must reach these businesses before they go bankrupt, if it is to have the desired impact of saving companies and stemming the tide of what could become mass unemployment.

However, even with the stimulus the outlook is tenuous. The US government’s stimulus package could help avoid a depression, but we believe it is still likely that the US, as well as at this stage Europe and Japan, will fall into a recession. This outlook is very dependent on how in the coming weeks the virus is controlled in Europe and especially the US.

Indicators to go back into the market

We expect that the virus will continue to spread, so we still believe it is too early to consider going back into the market. The core issue is pressure on the global healthcare system. As the epicentre of the virus moves westwards, the US healthcare system is starting to feel this pressure. Data suggest about 5% of victims are in a serious or critical condition³. If the infection rate is not controlled, it is highly likely that more people will require hospitalisation in affected regions than the healthcare system can accommodate, likely leading to a sharp rise in deaths. This in turn could lead to public demand for more draconian control measures that would become more harmful to the economy.

The first and overriding indicator to reinvest, is when this vicious cycle is broken. This would be when virus containment measures start working, after which the full benefits of economic stimulus could start having an impact. In view of this we highlight a list of indicators, which could signal when it is the right time to go back into risk assets:

Credible steps to contain the virus: There needs to be credible and medically sound measures. These include stringent lockdown measures to contain the virus. This is happening in some European countries, but the US is potentially most exposed, with the majority of states not yet in lockdown and President Trump announcing that he hopes the US will be open for business by Easter. The outlook for this crucial step remains unclear.
Infection rate curve stabilisation or flattening in the US and Europe: This is still escalating and we expect it could be at least 2 – 3 weeks before we see a flattening of the curve, if virus containment steps are implemented decisively.
Extreme valuations: US equity valuations are just below what we consider to be fair value, but are not yet extreme.
Extreme positioning: Markets have been moving at extremes of as much as +10% and -10%, but whilst the correction is unlikely to keep its breakneck speed, parts of the market are still vulnerable to weakness.
Effective monetary and fiscal policy: This appears to be largely in place. Central banks have acted decisively with respect to monetary policy, with the Federal Reserve announcing a $700bn asset purchase programme and a €750mn stimulus package from the ECB. The US government also announced a $2tn fiscal stimulus, described by Senate Minority Leader Chuck Schumer as the “largest rescue package in American history”. These initiatives can “ease the pain” of the virus’ economic impact and can greatly facilitate a recovery once the virus is contained. However, whilst these policies are positive, they do not break the vicious cycle of greater infection and so, to invest we still need signs of containment starting to work.

RISK CONSIDERATIONS

There is no assurance that the Strategy will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in this portfolio. Please be aware that this strategy may be subject to certain additional risks. There is the risk that the Adviser’s asset allocation methodology and assumptions regarding the Underlying Portfolios may be incorrect in light of actual market conditions and the Portfolio may not achieve its investment objective. Share prices also tend to be volatile and there is a significant possibility of loss. The portfolio’s investments in commodity-linked notes involve substantial risks, including risk of loss of a significant portion of their principal value. In addition to commodity risk, they may be subject to additional special risks, such as risk of loss of interest and principal, lack of secondary market and risk of greater volatility, that do not affect traditional equity and debt securities. Currency fluctuations could erase investment gains or add to investment losses. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes.Equity and foreign securities are generally more volatile than fixed income securities and are subject to currency, political, economic and market risks. Equity values fluctuate in response to activities specific to a company. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds ETFs and other Investment Funds, the portfolio absorbs both its own expenses and those of the ETFs and Investment Funds it invests in. Supply and demand for ETFs and Investment Funds may not be correlated to that of the underlying securities. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolio’s performance. A currency forwardis a hedging tool that does not involve any upfront payment. The use of leverage may increase volatility in the Portfolio. Diversification does not protect you against a loss in a particular market; however, it allows you to spread that risk across various asset classes.

¹ Source: 25 March 2020, CNBC.

² Cash is King: Flows, Balances and Buffer Days. JP Morgan Chase Institute. September 2016. Cash buffer days are the estimated number of days a company can pay out of its cash balance, were its inflows to stop.

³ Worldometers. www.worldometers.info/coronavirus/coronavirus-cases/ Site accessed 26 March 2020. Of the cases of COVID-19 globally 95% of those with the virus are in a mild condition, 5% are in a serious or critical condition.

Andrew Harmstone

Managing Director

Global Balanced Risk Control Team

Manfred Hui

Managing Director

Global Balanced Risk Control Team

Christian Goldsmith

Executive Director

Global Balanced Risk Control Team

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This document may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this document in another language, the English version shall prevail.rategy will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in this portfolio. Please be aware that this strategy may be subject to certain additional risks. There is the risk that the Adviser’s asset allocation methodology and assumptions regarding the Underlying Portfolios may be incorrect in light of actual market conditions and the Portfolio may not achieve its investment objective. Share prices also tend to be volatile and there is a significant possibility of loss. The portfolio’s investments in commodity-linked notes involve substantial risks, including risk of loss of a significant portion of their principal value. In addition to commodity risk, they may be subject to additional special risks, such as risk of loss of interest and principal, lack of secondary market and risk of greater volatility, that do not affect traditional equity and debt securities. Currency fluctuations could erase investment gains or add to investment losses. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes.Equity and foreign securities are generally more volatile than fixed income securities and are subject to currency, political, economic and market risks. Equity values fluctuate in response to activities specific to a company. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds ETFs and other Investment Funds, the portfolio absorbs both its own expenses and those of the ETFs and Investment Funds it invests in. Supply and demand for ETFs and Investment Funds may not be correlated to that of the underlying securities.