With a very healthy dose of humility, let’s take a look at what a reopening of the global economy may look like.
Data on coal consumption, railcar volumes, air pollution, etc., through early April all suggest China has been able to restore much of its factory output to more normal levels. Retail spending has been slower to come back on-line, however, even with most stores having already opened their doors.
In Europe, Denmark, Norway, Austria and the Czech Republic appear to be at the front of the pack in planning the restarts of their economies. These will be important litmus tests for the outlook in the broader developed markets.
Broadly speaking, we believe that an economic reopening will likely be defined by three key characteristics:
- It will be slow. For example, in the United States, some states have closed their schools for the year through June, which will make it difficult for parents to fully return to their offices.
- It will be complicated. For instance, New York is coordinating with Connecticut and New Jersey on a regional get-back-to-work plan, given the interlinkages of their transit systems and economies.
- Done correctly, it will have to be careful. Rigorous testing, safeguarding vulnerable populations and a staggered approach will be likely, if not required.
In other words, the switch won’t be simply flipped from off to on again overnight. The global economy’s transition back to a relative state of normalcy will be slow. But it will a transition nonetheless – better than being permanently stuck in the off position. And ultimately, for markets – where less bad is often good – this is what may matter most.
The impact of global containment measures
Since our last update on April 8, daily COVID-19 cases in Europe and the United States are plateauing. Containment measures are slowing the spread of the disease and making this terrible burden a bit more manageable for health systems. But it also shouldn’t be that surprising as, for example, in the United States, 95% of the population has been told to stay at home. And it is precisely because of these restrictions that the economic consequences have been devastating.
U.S. unemployment rate may be near 15%
Last week, data from the U.S. Department of Labor showed another 6.6 million Americans filed for unemployment benefits, which, coupled with losses in prior weeks, suggests the unemployment rate may now be around 15%. The good news? We already knew the data was going to be ugly in April – and the policy support keeps rolling in.
More help from the Fed
Last Thursday, the U.S. Federal Reserve (the Fed) announced more programs that collectively could add $2.3 trillion of support to the U.S. economy. I won’t bore you with the details, but there are two particularly noteworthy considerations for investors.
First, the Fed isn’t done. It still has roughly $300 billion of Treasury capital remaining from the CARES Act that it can lever up to provide another $3 trillion of support (plus or minus a nickel). Second, the Fed has expanded its corporate bond program beyond investment grade securities, now allowing it to buy high yield bond ETFs and fallen angels.1 For some context on the latter provision, the cost of insuring against a default on Ford Motor Company (F), one of the largest U.S. fallen angels, was cut in half around the announcement late last week.2
Strong policy support across the globe
The shift toward policy support continues to be a global phenomenon. The most significant among these last week came from Japan, which approved a $1 trillion stimulus package, equivalent to almost 20% of GDP (gross domestic product).
Markets are forward-looking and have focused more on the improved virus trajectory and substantial policy support than the bad economic data. We’ll have to wait and see if that trend carries through the U.S. earnings season, which kicks off with the big banks tomorrow. But even with some moderate selling pressure this morning, the MSCI All Country World Index has rallied about 20% since the close on March 23. Or, if you prefer your glass half-empty, we’ve recovered about 40% of the peak-to-trough decline in global equities.
Will the market rally continue?
If developed market economies are able to gradually reopen in the second quarter (and stay that way), markets should continue to rally. However, if that reopening causes another major wave of outbreaks – similar to the Spanish flu in 1918, which hit in multiple waves – a potential reinstatement of containment measures could have markets retesting their March lows. This is a known unknown that investors are forced to grapple with. On a 12-month horizon, we are positive, given cheaper starting valuations on global equities and credit, in addition to massive fiscal and monetary policy support. But, importantly, we believe upside and downside volatility are likely to remain elevated given the unpredictability of the virus.
1 Companies that were rated investment grade (BBB+) before the outbreak but have subsequently seen their credit ratings fall to BB.
2 Based on pricing for a 5-year unsecured credit default swap. Source: Thomson Reuters Datastream. Fell from roughly 1400bp to roughly 700bp.
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