Investing in a post Covid-19 world
As the coronavirus sweeps its way around the globe, the trends established in most countries in terms of taming its spread after lockdown appears similar to that set in China. While it might take somewhat longer for some of those countries that started their control measures later, the outlook seems positive and the trend is definitely moving in the right direction.
Metrics indicate that we are approaching peak infections and peak death rates in some of the largest economies in the world and we have seen a bit of a relief rally in global equity markets as a result, further fuelled by a record amount of stimulus provided by most countries’ central banks.
In South Africa, it would appear that our Covid-19 curve has also been flattening. This comes at a time that the number of tests has been increasing rapidly, a positive indication that our numbers are reflecting the real impact within the community. The figures imply that, in line with global trends and given our early lockdown, we will probably be able to bring the virus under control.
Looking at the economic impact in China, we note that the services Purchasing Managers' Index (PMI), an indicator measuring whether the economy is expanding or contracting, dipped severely going into the crisis, but rebounded sharply as the economy began opening up again. In line with this, the Q1 GDP print for China was -6.8% and from here, as long as the Chinese economy can remain open, a recovery of a similar magnitude as the PMI seems likely.
A comparable picture might be possible for economies around the world – as they each open up, a recovery becomes possible. In the UK and the US, for example, the metrics are reflecting tougher conditions now than occurred during the 2008/9 global financial crisis. But in both instances, we expect a turnaround when the economy reopens, given the enormous stimulus packages already in play.
In the US, with its flexible labour market, there have been significant job losses and an unemployment rate jumping from its multi-decade low of 3.5% to 4.4% in March 2020. This is a clear indicator that the world’s top economy is headed into a recession, and unemployment may quickly increase to double digits over the next few months.
With overall demand having taken a hit, and oil demand in particular suffering with record low prices being recorded, inflation is unlikely to be a problem globally in the medium term and for now is expected to remain muted. In the longer-term, however, given the level of stimulation packages around the world, we can anticipate inflation.
Company earnings are sliding
We expect to see considerable downside pressure on earnings for the coming year as a result of the recession and the disinflationary environment. Given this, the market rally experienced to date is unsustainable. The markets will probably pull back again and we expect there to be more volatility in the pipeline, so it’s important that portfolios are correctly positioned for that.
The major fear for South Africa, however, is that we will see a depression rather than just a recession. We entered lockdown already in a recession and the economic trauma that it has brought is serious. On top of that, we have significant structural issues and we can but hope that there will be the same political will to address the economic issues that we have seen in terms of addressing the Covid-19 crisis.
With a sharply weakening growth rate and, worse, the gap between economic growth and population growth widening substantially, we can expect rising unemployment and possible social unrest. Support for the economy during this time is vital, and preparing the groundwork now for a restructured, enhanced economy will prove crucial to the future success of the country.
There will be winners and losers
Economies are likely to display a strong rebound given the fiscal and monetary support, although focused more on the physical side of the economy with services notably lagging. The travel, leisure and hospitality industries are some examples of those which will take some time to return to normal.
We expect that the digital economy will be embraced fully as Covid-19 breaks old habits from the industrial generation, such as driving to an office.
Many of the winners will be online, and this is where to look for opportunities for equity investments. Unfortunately, this means that there will also be losers such as the terrestrial companies and airlines.
This is also a presidential election year in the US, and the outcome will be crucial for where the world is headed in life after Covid-19. The country can follow one of two paths, and they seem to be based on whether Donald Trump retains the presidency or not. It could embrace a move from isolation to international cooperation with a focus on a new way of globalisation supporting economies and global financial markets. This would seem likely if Trump does not win the election. By contrast, the opposite route would be one of more protectionism, anti-globalisation, blame and tension, if not war – a more likely outcome in the event of a Trump win which will negatively weigh on markets for years to come.
Implications for investors
Over the past quarter, investors began to price in the increasing likelihood of a global recession, sparking the strongest, deepest and quickest market sell-off in just a few weeks – with faster declines than those seen in either the 1929-1939 Great Depression or the snap crash of 1987. However, since the “bottom” in late March, markets rallied on the back of renewed stimulation and the evidence of peak infection is apparent in most countries.
As the economic pain only started now, with more downside for economies, consumers and companies, this market rally seems unsustainable and the risk remains that markets will test the recent lows in months to come. Investors should remain defensively positioned with alternative strategies and a focus on selecting quality assets and companies (those with strong balance sheets and lower levels of debt) until markets present a better opportunity to increase exposure to equities.
Global cash and bonds, specifically in the US, have added significant protection over the tumult of the past few months. However, with investors rushing into US bonds as a safe-haven asset, and the Fed cutting interest rates to 0%, much of the protection value offered by these assets is already in the price. Therefore, unless depression becomes more likely, US bonds now appear quite expensive.
On the domestic front, local interest rates are coming down, and one should therefore only keep enough cash in a portfolio to cover the next few years’ expenses. The fixed-income market (government bonds) is in a very different space. Now that the credit downgrade has been priced into the local bond market, current yields are much more attractive and one should consider an increased allocation to the bond market. With yields currently in double-digit territory and inflation low and well maintained, this allows investors to lock in some of the highest real yields available in the world today.
The local equity market, meanwhile, is likely to face severe headwinds in the form of bankruptcies and defaults on the back of a slow economic recovery. That said, many companies will survive and are trading at favourable valuations, which creates the opportunity to include a few quality local companies with good growth potential at historical discounts into your portfolio. However, given the local headwinds, an overweight to quality global companies that should benefit from faster recovering economies with fewer structural hurdles makes more sense.
Lastly, the rand is likely to remain under pressure during this phase, especially until South Africa is excluded from the World Government Bond Index. Look for the currency to reach its weakest level in the next few weeks and then to start moving stronger towards the end of the year as the US dollar rally runs out of steam and currency markets begin to price in the reality of zero interest rates in the US.
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