Recovering from the Virus – 30 April 2020

Steven Bell

Managing Director, Portfolio Manager & Chief Economist, Multi Asset Solutions

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Risk Disclaimer 

The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

To understand the outlook for financial markets, we need to assess the scale of the recession, consider the profile of the recovery, and what that means for corporate earnings. This all depends on the virus.

Steven Bell rounds up the month’s economic news and answers your questions on the outlook for financial markets.

  • We are winning the war against the virus, but the economic costs are huge.
  • The speed of the downturn is breath taking. Huge chunks of the economy have been closed down by government dictate, and earnings estimates have been slashed, and we don’t think the slashing is over yet.
  • It is not until late 2021 that the UK economy is likely to recover to pre-virus levels of economic activity. Unfortunately, many businesses will go bust, but more will survive, due largely to the government intervention, but also because the recession will have been so brief that skills will not have been lost.
  • Markets will move higher, but the easy gains are behind us.

Risk Disclaimer

The value of investments and any income derived from them can go down as well as up and investors may not get back the original amount invested.

The information, opinions, estimates or forecasts contained in this document were obtained from sources reasonably believed to be reliable and are subject to change at any time.

Q&A with Steven Bell

I believe the virus data has been as accurate as they could make it. They did revise the data but that was because they were initially only counting hospital deaths, like the UK currently does, and this was changed to include care home deaths and deaths outside of hospitals.

Regarding the data for the effect on the economy, such as reduction in traffic, decreased coal consumption due to the cessation of manufacturing, and so on, can be verified by live data from satellites, and the story here is consistent, so I think their economic data is as accurate as anywhere else.

It is a lot easier to talk in terms of the S&P500, as the FTSE100 is heavily influenced by the strength of sterling, which is very difficult to predict, as well as heavily influenced by the fortunes of oil companies, Shell has slashed its dividend this week, a big shock. I think the FTSE will struggle against the S&P. For the S&P500, we could easily see it falling a few hundred points in May; if the index gets back down below the 2,800 level then I think it will be a buying opportunity. I believe we are back in a much more ‘normal’ market environment, we are not going to get the huge gains, nor the huge losses that we have seen recently. These were down to the extraordinary technical dynamics that pushed the market down unprecedentedly quickly, and also partially caused the subsequent rally. And I think the headwinds as well as the positive factors were at their most extreme levels. We are likely to get a setback in the near future but the base trend for the US equity market is higher.

To some extent it already is. China had its worst GDP number in Q1, industrial production is back up to 80 to 85% of where it was before, and this is depressed by the collapse in the global economy, so it pretty much means a full recovery. Consumers are cautious, there are restrictions in cinemas, subway traffic is well below the pre-virus level, but I think the message from China is that they are getting back on track quite quickly. This is an encouraging profile for other economies although it is important to note that China’s lockdown was much more severe and more adhered to than others.

Normally in a recession, quality would outperform and in the subsequent rally, lower quality names, as well as value stocks outperform. That is not the case at the moment. The companies that have been the strongest in recent years, the tech companies, have continued to outperform through the current extreme market, Facebook’s numbers this week confirm that. We think that, in terms of the US, growth stocks will continue to outperform. The financial sector will struggle, particularly European banks; the negative news on earnings has been dominated by very high provisioning for bad debts. The recovery will be unusual in that it will be led by those that led on the way down. With regards to oil, current prices are unsustainable – ignoring WTI which is down to storage facilities, the price of Brent crude is lower that the cost of production in most areas. Demand for oil has fallen by 30%, so the OPEC+ supply cut of 10% is not enough. Prices need to go higher; whether they will get back to the $60 per barrel levels, I’m sceptical.

Clearly before this crisis, the ‘Silicon curtain’ was descending between China and the United States, and globalisation was being reversed, which gave an extra push to the US-China situation. It is a big issue on the upcoming US election; there have been adverts attacking Biden for being too soft on China, and there has been similar rhetoric against Trump as well. Whoever ends up in the White House is not likely  to ease up on China, there will continue to be antagonism as this stance plays very well with the American public. Having said all that, there are still a lot of big US companies producing good in China, for example Apple, and I don’t think that is likely to change. China is moving very fast towards self-sufficiency, domestic production of chips and the roll-out of 5G; the previous era of a close relationship between the two has gone.

Firstly, on inflation. In the GFC when central banks embarked on quantitative easing, many people, including policy makers, feared that this would lead to inflation – it didn’t. Inflation tends to arise when you get a collapse in confidence in a country’s government and in its currency. We are nowhere near that situation. We have seen it recently in Zimbabwe, Argentina and Venezuela in recent years, but that is not the situation we are in now. Deflation is more of a worry. When it comes to interest rates, I think they will stay low. I think bond yields are too low, they are being held down by government pressure, but I do think they will start to edge higher. Consumers will want to pay off their accumulated debt, which will depress consumption temporarily, businesses will act similarly. But governments do not need to – their borrowing is like an interest free mortgage with no term, they can just roll it over, so I don’t think we are in for a period of high austerity, governments will just live with the higher debt.

Regarding Germany, this was a recent comment in a press conference, which is incorrect. Yes there are day-to-day fluctuations in the numbers, but Germany has only just started to ease its lockdown and the lag is 14 days so there wouldn’t have been a response to any infection rates yet. Regarding the Gilead trials, and very small trial has some success but it was not a properly documented mass trial and until that happens we cannot rely on any results with confidence. The really positive news will come with a vaccine and that takes much more work and time.

For 2021, some sectors will remain depressed, for example I don’t think we will go back to using airline travel quite as readily, same for cinema attendance, but I think we will more easily go back to other previous habits and these sectors will rebound quickly. We will recover to previous levels of GDP and corporate earnings in aggregate, with some sectors seeing a permanent higher level, for instance, online shopping will likely continue at an elevated level than pre-virus. So there will be a shift in earnings patterns but with an overall higher level. I think equities will outperform bonds and risk assets will continue to be the place to be over the longer term.

Listen to the full playback of Steven Bell’s latest webinar, Recovering from the Virus

 

 
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