The start of the second quarter coincided with a turn in the equity market. The rebound from the low point was as rapid as the fall, with global equities rebounding by over 16% in three days at the end of March. The bottom of the market was sharp and was driven by a significant liquidity dislocation and pricing anomalies as investors rushed to exit most assets in favour of dollar cash.
Over the quarter investors appear to be increasingly encouraged that lockdown regimes in Europe and the US are being eased and the peak of infections has now passed. While the market has risen, there continues to be a significant divergence in companies’ fortunes and share prices. Those business models that can remain operating with only minor disruption or even take advantage of the current situation have seen a speedy return of investor support, and often reached new highs. Large US tech companies are the primary beneficiaries of this and given their substantial weighting in global equities, and this has helped markets rebound. Nevertheless, it is astonishing to observe that the US market is now only 8% down (as at 23/06/2020) from the levels seen before the COVID selloff in February, a level that many believed was already looking overvalued. It is not a dissimilar picture in other major equity markets.
As time has passed, the economic impact has become clearer. US employment data is revealing one of the most severe and swift shocks to the jobs market ever recorded, with over 40m Americans filing for unemployment support and the headline unemployment rate breaching 14%. Unfortunately, it is likely to be an underestimate of the actual position as there will also be significant underemployment. This mirrors the situation in the UK, although the furlough scheme is shielding many of the otherwise unemployed for the time being. Still, some companies are making decisions now to lay off workers, in acknowledgement of the likely weaker demand in the medium term. Economists are expecting the data to get worse before it gets better.
As a result of support schemes as well as a deteriorating economy, the impact on government finances has been severe. The UK government borrowed over £60bn in April alone, and it is expected that for the fiscal year, it will be £300bn. This is equivalent to around 14% of GDP and will take the debt to GDP ratio to well over 100%. While borrowing costs are expected to remain low, such a heavy burden may weigh on the economy for many years to come as future chancellors look to increase revenues and cut spending where possible, in an attempt to reduce this figure. Previous wisdom suggested that a government debt level in excess of 90% to GDP would cause a drag on growth, although, many old assumptions are being shattered in the current environment. A return to a higher level of inflation may also be looked upon favourably by borrowers as well as central banks, as it will reduce the real value of liabilities.
Looser monetary policy has already been used heavily during this crisis; however, there are still signs of more to come and some policies that were once considered taboo are now being openly discussed. In the UK the possibility of negative interest rates is now being seriously considered, and increasingly central banks are contemplating extending asset purchases more broadly, to include high yield bonds and equities in addition to government and corporate bonds. While there may indeed be a speedy end to lockdown measures, the damage done to the economy and the speed of any rebound remains highly uncertain. Furthermore, the potential of a second peak and/or a more gradual lifting of restrictions remains a risk. Most management teams are therefore applying significant uncertainty to any forecasts, or withdrawing them altogether.
With such a heavy focus on coronavirus and its impact, otherwise important events may also be going under-reported and potentially underappreciated by investors. The most prominent of these is the China-US tensions that had been simmering, and which are now flaring up once more. US accusations towards China over the pandemic and Chinese actions in Hong Kong have meant that it is increasingly likely that relations will sour going forwards. Furthermore, with such a large amount of disruption already occurring, both countries may be willing to take a more aggressive stance than they have before. While this issue may now be small in comparison to the colossal problems caused by Covid-19, it may come increasingly into focus as the world begins to return to normality over the coming months and years.
Elsewhere, the oil market has been very volatile, illustrated by the WTI futures market trading negative for the first time in history. The falls were a response to rapidly weakening demand and a reluctance by OPEC to restrict production. However, as a consensus was found and US production began to decrease in response to the falling price, the market began to improve. As a result, oil is now trading around $40. This is still depressed relative to “normal”, although it is expected that demand will remain weak for some time and there will not be any supply pressures, with plenty of spare capacity.
In the key areas of US and Europe, the coronavirus peaked at the beginning of the quarter. Nevertheless, new outbreaks in Latin America and a potential second surge in US cases mean that there continues to be growth in overall case numbers globally. There is difficulty in interpreting the data as factors such as increased testing will inherently lead to higher numbers, even if there was no change in the underlying rate of infection.
Overall, the general consensus is that the worst is passed, and the pandemic has not overwhelmed the world’s healthcare systems. However, there is a real possibility that there are subsequent waves, at least in certain countries. The greatest risk to markets would be another flare up in the US, where there is existing strong opposition to a lockdown.
More positively, there is evidence from early easers in Asia as well as Europe that countries can emerge without seeing significant increases in infection. However, it may still be too early to tell as individuals and government are still on high alert. What appears most likely is that there are a series of epidemics in countries and regions globally which may restrict travel and trade in the medium term, even if individual economies begin to “unlock”.
Given the importance of the US in the global economy and financial system, clearly there is a lot of focus on the progress of the pandemic there. One potentially concerning development is that while New York (the original centre of the outbreak in the US) has largely brought the virus under control, several other states have seen continuing growth in cases. As restrictions ease across the US, the rate of growth in these states is accelerating. Indications that the virus needs to once again be suppressed may lead to slower easing of restrictions or a re-imposition of more aggressive lock down measures, at least at a state level. Of course, the US may resist these tactics, but more widespread infection may well have a similarly negative impact on confidence and the economy.
Eagle eyes will be watching if the easing of lockdowns in Europe will cause another build-up of infections. The initial signs are encouraging, although, there are signs that some countries may be developing a second wave.