Early signs of bottoming but headwinds remain

The efficacy of lockdown measures, strong policy support, easing of liquidity constraints and cheaper market valuations help set the stage for the start of a bottoming process, which can historically last for several months.

Apr 2020 | 3.5 min read

As the coronavirus spreads across the world, the global health crisis has morphed into challenges for both the global economy and financial markets.

Global activity has collapsed dramatically in the last 2 months, following the lockdowns in multiple countries. Equities fell across both developed and emerging markets and analysts have revised earnings expectations lower. High quality USD assets outperformed on the back of safe haven flows and the strong USD further weighed on emerging market assets. Liquidity tightened across all asset classes, with the US and Asian high yield bond markets among the worst affected as default fears spike.

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Signs of hope

Amid the uncertainty over the duration of the lockdowns, impact on economies and potential exit strategies, we see the following signs of hope:

Efficacy of lockdown measures

Containment measures, if implemented properly, can get the outbreak under control. We have seen fatalities plateau in Spain and Italy to date.

China has shown that aggressive lockdown measures can work and will allow business sentiment to rebound when normality resumes. China’s Official NBS Manufacturing PMI surged to 52.0 in March 2020 from a record low of 35.7 in the previous month, as many companies resumed operations. Its non-manufacturing Purchasing Managers’ Index rebounded to 51.8, up 21.7 points from February with expansions seen in the transportation, retail sales and banking sectors.

Strong policy support

Policymakers, armed with the lessons from 2008, have moved quickly to prevent a financial crisis from developing. The Federal Reserve (Fed) has cut rates, restarted quantitative easing, extended swap lines and more recently, resurrected the Commercial Paper Funding Facility (CPFF). A smooth functioning of the commercial paper market, which supplies credit for auto loans, mortgages and to companies, will help support families, businesses and jobs.

In the US and Europe, fiscal stimulus has amounted to 10% of GDP and 5% of GDP respectively. The fiscal stimulus provided to date in many countries exceeds what was provided during the Global Financial Crisis (barring China). See Fig. 1. Asian policymakers too have also responded with aggressive monetary easing and fiscal stimulus, with the latter ranging between 0.2% and 10% of respective country’s GDP. Within Asia, Japan stands out with its recent announcement of a huge fiscal package amounting to almost 20% of GDP.

Fig. 1. Global fiscal stimulus exceeds 20081


Improved liquidity conditions

The powerful combination of fiscal and monetary policy responses globally has eased liquidity conditions across the markets. We have seen commercial paper borrowing yields fall, the costs for overseas creditors to borrow USD decline and global credit spreads narrow. As the Fed resumes its purchases of US investment grade corporate bonds, US and Asian high yield bonds have benefitted from the positive spillover effects. In the equity markets, volatility has also edged lower from recent highs.

We believe that the loosening of liquidity constraints should limit the risk that this pandemic outbreak results in anything more than a cyclical, albeit sharp, slowdown.

Cheaper valuations

Price to book valuations suggest that the correction has created opportunities for long-term investors. While the price to book valuation of MSCI USA, for example, is currently below its long-term historical average, the valuation for MSCI Asia Pacific ex Japan is approaching its 2008 lows. See Fig. 2.

Fig. 2. MSCI Asia Pacific ex Japan – Price to book2


Credit yields also look attractive at current levels. Compared against US Investment Grade bonds, the spreads for Emerging Market bonds are wide relative to history. That said, some caution is warranted as many Latin American issuers in the Emerging Market Bond Index are suffering from both the downturn in global activity and more recently, historically low oil prices.

A bottoming process

Stock and credit markets have responded positively to the unprecedented policy responses and have partially retraced prior declines. We believe that this is the start of a bottoming process which can historically last for many months.

For now, we maintain a neutral positioning towards equities within our multi-asset portfolios. While valuations are attractive, the technical indicators we follow as part of our proprietary analytics platform “LOGOs”, are mixed. Meanwhile, fundamental indicators such as business sentiment, equity earnings revision trends and macro risk measures remain poor and continue to present headwinds for the equity markets. We would need business sentiment to improve before we are convinced that the recent rebound in the equity markets is sustainable.

Nevertheless, we are taking advantage of the market dislocations in the derivative markets caused by the high levels of volatility. We have, where possible, implemented option positions which have already added value to our portfolios.

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