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April 08, 2020

Coronavirus: Markets’ excessive optimism

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April 08, 2020

Coronavirus: Markets’ excessive optimism


Coronavirus: Markets’ excessive optimism

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April 08, 2020


The unprecedented stimulus provided in many regions may not be a panacea. As a public health crisis, credible efforts to contain COVID-19 are also crucial. This has some serious economic ramifications, many of which have not yet materialised and which we believe markets are not pricing in. We are wary of what we see as excessive market optimism and this is the focus of this week’s update.

US equity ETFs had outflows of $1.98bn in February, followed by substantial inflows of $23.1bn in March1, suggesting many investors were buying the dip. We believe this is likely a temporary recovery. Whilst the risk-reward potential has improved over the long-term, we expect markets to retest previous lows in the short-term, which appears to already be happening for sectors with the weakest fundamentals such as European Banks2.

Some investors are predicting a very sharp hit to growth in Q2 followed by a V-shaped recovery in Q3. Many are now assuming a ~30% hit to EPS, and an EPS recovery of ~+50% in 2021, which is even sharper than the 40% seen in 20103. This bullish scenario assumes that when lockdown measures are lifted, business will resume as usual. We believe this is unrealistic and will lead to markets being disappointed. We have outlined some of the key factors which markets may not be fully reflecting:

Early data indicate severe recession

Global Services PMIs4 have plummeted. Companies have already cut dividends, buybacks, staff, unnecessary costs and capex, but this may not be enough. If bankruptcies increase, unemployment will spike, impacting consumption. Last week’s US jobless report showed an immediate impact with 6.6mn claims5, doubling the record 3.3mn from the week before and suggests millions in the US are likely in need of funds.

Bureaucratic hurdles

Despite the US government’s promise of support, large bureaucratic hurdles mean funds may not be received by households and businesses in time. The small business loan or “Paycheck Protection Program”6, is experiencing issues. It is administratively tough for the federally-insured banks issuing the loans to process the vast number of applications, including verification of eligibility. Consequently some applicants have been refused loans due to lack of a prior relationship with the bank. Moreover, these measures aim to keep businesses and households afloat for a certain period. If the state of emergency is prolonged, even more stimulus may be required and this is already being proposed in Congress.

Protracted period of isolation and border restrictions

Even once a country is in recovery from COVID-19, some isolation is still likely for the remainder of 2020. For example, Singapore was initially praised for its management of the virus, but a second wave of imported cases has led to stricter lockdown measures. When a country eventually recovers and lifts its lockdown measures, business may not resume as usual, as other countries may not have recovered and re-opened borders. Given the travel sector represents approximately 10% of global GDP, this factor alone could have a great impact.

By the time the lockdown measures are lifted, the damage to the economy may already be irrevocable. This suggests further downside and that the current market optimism is premature. We believe that a V-shaped recovery is unlikely and see a U-shaped recovery as the most optimistic case.

Our list of indicators to re-invest in risk assets

In the next several weeks the US economy will approach an inflection point, as we see whether virus-affected businesses receive stimulus approved by Congress before they go bankrupt. We continue to focus on the following factors to help determine the right time to increase exposure to risk assets globally, including equities. We still see little improvement in the status of these indicators:

1.   Credible steps to contain the virus and flattening of the infection rate curve:Whilst many European countries have taken credible steps, the US is far behind. The infection rate may be slowing in Europe generally, but in the US there is a risk of outbreaks intensifying outside New York City, the current epicentre. There does not appear to be a credible, coordinated nationwide virus containment or suppression plan.

2.   Extreme valuations: Current developed market valuations, while more attractive by historical standards, are not at levels that we believe generally characterise a positive turning point in market direction.

3.   Extreme positioning: ETF flows indicate that equity positioning is increasing and many investors appear positive about the future market direction, driven by “fear of missing out”. However, overall fear has not yet replaced greed. We believe that at a market bottom, investor sentiment generally reflects “fear” not “greed” and equity positioning would be falling not rising.

Effective monetary and fiscal policy: The policies appear to be largely in place and it has been made clear that more fiscal stimulus may come, if required. However, the implementation, especially in the US, is encountering many bureaucratic delays and segments of the economy are not yet eligible, yet require funding. Speed is essential to prevent bankruptcies, which could trigger a downward spiral, tipping the economy into deeper recession than is already likely.

Tactical Asset Allocation Changes

Below we have provided an overview of our latest, key tactical asset allocation change:

Emerging Market Local Currency Debt: Moving from Neutral to Underweight

Emerging market economies are likely to weaken further given the triple shock of a global recession, weakness in oil prices and a pandemic. Compared with 2008, emerging market economic fundamentals such as current account balances, FX reserves and fiscal balances are in a weaker position to weather this downturn. Furthermore, the number of COVID-19 cases in emerging markets has also started to escalate. Populations in these countries tend to be heavily undertested and medical resources are constrained relative to developed markets, so are less equipped to tackle the virus or provide effective containment measures. Finally, many emerging market central banks and governments have not provided swift and effective monetary and fiscal stimulus. Consequently we expect the asset class to remain volatile with further downside risk.



1 Bloomberg data, BI ETF.

2 Based on the Euro STOXX Banks Price (EUR) Index.

3 Based on S&P 500 12-month trailing EPSg. Source: Datastream, IBES, 2 April 2020. EPSg is earnings per share growth.

4 Source: Datastream. March 2020 IHS Markit Services Purchasing Managers’ Index (PMI). 

5 U.S. Department of Labor. 2 April 2020 and 26 March 2020. ”The previous high was 695,000 in October 1982.”

6 This is a government-backed loan for businesses with fewer than 500 employees.




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