As an indiscriminate rush to sell assets abates, it’s the turn of the exit trade to dominate markets. And from here, only one exit truly matters: the doorway beyond lockdowns that have suspended large tracts of the economy.
Any easing in lockdowns marks just an initial step. The return of daily routines and businesses approaching any semblance of normality will take plenty of time, compounding the financial strains bubbling away at the moment for many companies, businesses and households.
Rather than reacting sharply to shocking economic data (Friday’s European service sector figures) and the US employment report for March (showing a loss of 701,000 jobs), investors stuck at home in self-isolation are focused on the daily rates of Covid-19 infections for clues as to when lockdowns can ease across much of the global economy.
There is a slither of good news. Infections across Italy and Spain are showing signs of cresting, but unfortunately Singapore is the latest country facing a renewed wave of coronavirus cases.
The pandemic news from other countries, particularly in the US, is truly dreadful. BCA Research notes:
“The US, now the global epicentre of the pandemic, has been closely tracking Italy’s daily new case count on a per-capita basis with a 2-week lag, and we will be watching for any deviation from this benchmark.”
From tracking the trajectory of infections, the market debate turns on when economic activity will start expanding.
Mark Dowding at BlueBay Asset Management believes the “enormous strain on economies and societies” from lockdowns can only persist until the end of April before “those who have developed immunity, as well as the young and the healthy . . . return to work by the beginning of May”.
That does not rule out new lows for financial markets, but there are now two types of assets: those that benefit from official support such as government and highly rated corporate debt, and then the rest.
Among the more vulnerable areas are emerging markets and lower-quality credit markets. Many EM countries lack healthcare systems to handle an escalating global pandemic that has certainly challenged far richer nations.
EM currencies remained under pressure on Friday, with not even a rebound in oil helping Mexico and Columbia. This situation underlines the primacy of the US dollar. Until risk appetite turns positive, a strong reserve currency will maintain significant pressure on the global financial system.
This chips away at the idea that central bank and government measures are a form of stimulus that will eventually pave the way for a sustained rebound in the economy and markets. Faith in stimulus has arguably helped global equities and high-yield credit find buyers of last month’s massive dip in prices. The latest fund flows data revealed $7bn chasing US high-yield debt, a record weekly inflow that snapped five weeks of massive outflows.
An alternative take is that official measures are a form of support that has so far prevented deeper financial market turmoil. A strong dollar and more signs of EM and risky credit stress from here will be warning signs.
Andrea Cicione at TS Lombard argues the shock stage of the pandemic, marked by “high volatility in markets and unusual correlations”, is simply the first of three phases. At this juncture, there are signs of a shift towards the second phase, “the macro consequences”, with the final “post-virus period (a ‘new normal’)” still far away for now.
Muddying the waters for investors trying to gauge fair value and establish a floor are the massive support measures deployed by politicians and policymakers that distort prices for government and investment-grade corporate debt.
Andrea notes that as “policymakers have resisted the urge to buy equities” (at least for now) “this is the asset class that is most likely to settle close to its fair value”. This means stocks have room to fall further and set new lows when the full extent of the damage inflicted on earnings unfolds in the coming months.
In turn, a lengthy recovery marked by a process of testing, isolation and rolling lockdowns will challenge risk sentiment a lot more than what the market is currently pricing.
Andrea cautions: “Investors are underestimating the impact of second- and third-order effects on growth” such as “rising unemployment, falling capital expenditures and tighter financial conditions.”
Still, there is a case that no matter how grim things look at the moment, those with patience and a long-term view will prosper from the eventual revival of economic activity and asset prices. As seen in early 2009 and late 2002, a turn for the better in high-yield debt was the signal that told you the next cycle had begun.
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Quick Hits — What’s on the markets radar?
Crude oil prices are retaining support on expectations of new production cuts but, as noted on Thursday, the scale of the demand shock is immense and there’s plenty of scepticism about deep production cuts ahead of Opec’s virtual meeting next week.
The FT’s David Sheppard looks at whether the world will really unite to place a floor under the oil market.
At Capital Economics, its strategists are sticking to a $45-a-barrel forecast for both WTI and Brent by the end of the year, with a recovery in crude prices “premised on demand rebounding as the pandemic is brought under control in much of the world and the lockdown measures are lifted, rather than on some sort of agreement between Russia and Saudi Arabia”.
The US employment data for March were far worse than forecast and provides a foretaste of a steep rise in the ranks of unemployed workers.
The Conference Board highlighted how “almost 60 per cent of the entire job loss came from one industry: food services and drinking places”.
The rise in earnings is hardly comforting as “large lay-offs of mostly low-paid workers raised the average pay”, added the CB.
Economists at Bank of America expect a further escalation in jobless claims towards 20m “will translate into the unemployment rate reaching 15 per cent if not higher in upcoming reports. The March report is just a sneak peek of what is to come.”
On that rather gloomy note, a safe weekend to all readers. The feedback of late has been very welcome and constructive while I pen these notes from home and try to make sense of where the coronavirus journey takes us from here.
Your feedback
I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.
Source: Economy - ft.com
