The global caseload for the Coronavirus is now in excess of 9 million people and the total number of fatalities is closing in on half a million people. Currently the focus is clearly on the Americas, with new cases rising in both Latin America and the United States.
In Europe, a spike in cases led to a new lockdown for around 370,000 inhabitants of the Gütersloh district in north-west Germany. This news, along with an increase in the estimate of the effective reproduction number for Germany produced by the Robert Koch Institute (to 2.88), has attracted considerable attention.
In the US, the number of the new daily cases is rising, driven by the big states in the south and west, such as Florida, Texas and California. It is important to keep in mind that deaths are still on a declining trajectory but active COVID-19 hospitalisations have risen in some states to levels last seen in mid-May. These developments have understandably raised fears of a second wave although Dr. Michael Osterholm, a prominent US epidemiologist, framed the problem in a different (and arguably even more alarming) way: “I don’t think we’re going to see one, two and three waves — I think we’re just going to see one very, very difficult forest fire of cases.”
More broadly, the World Health Organisation warned on Friday that “the pandemic is entering a dangerous phase, with people tired of staying home and countries eager to reopen economies, but with COVID-19 activity still spreading fast and much of the world's population still susceptible”.
Turning to the macroeconomic data, the latest set of Purchasing Manager Indices (PMI) were published this week (see Exhibit 1 below). These data remain a key signpost of economic activity for investors – more timely than the official data on activity. Eurozone data were collected between the 12 - 22 June and the numbers continue to present a puzzle. In theory, companies are asked whether output is up or down on the month, and a net balance of 50 on the survey implies that an equal proportion of companies are reporting moves in output in each direction.
If we consider the recent history of the Eurozone PMI services activity balance then we are invited to conclude that activity continued to contract between May and June, after severe contractions in March, April and May. At best, one could describe the trajectory of the recovery as L-shaped. This conclusion does not tally with basic intuition: with economies starting to recover it seems hard to believe that activity was still falling between May and June. Indeed, a whole suite of indicators which capture economic and social mobility point to a gradual return to normality. We suspect that many investors have chosen to focus instead on the overall level of the PMI – effectively ignoring how the data are constructed and the relevance of the 50 “no change” point – whereupon the significant bounce between May and June is taken as evidence of a V-shaped recovery. The truth we believe lies somewhere in between these two alphabetical extremes.
• Financial conditions continue to improve, led by lower real yields, better funding conditions and steeper interest rate yield curves. In the US financial conditions are fully accommodative. In Europe they are restrictive but easing. We continue to expect further tightening of credit spreads and a normalisation in volatility over the summer. This could create a positive backdrop for the economy and markets.
• In Europe, the new TLTRO take-up by banks was very enthusiastic, given the generous funding rates offered. The strong peripheral bank participation could mean that support for peripheral government bonds is likely to remain strong. Moreover, we expect the new TLTRO to help ease lending conditions. Overall, it should support European bank earnings and be positive for the European economy.
• Inflows into riskier assets (high-yield bonds, equities and emerging markets) continue as the market stabilises. In equities, while inflows into tech continues, a rotation is apparent into risker cyclical stocks. Outflows from money market funds are accelerating. Excess cash, which had sought a safe haven during the height of the pandemic, is now looking for better returns. This should continue to drive demand for risky assets and a compression in risk premia over the summer.
• Equity markets continue to rebound in spite of weak 2020 earnings. Equity markets appear to be looking past 2020 to 2021 where earnings estimates are in line with 2019 earnings. Given the significant drop in US interest rates this year, US equity risk premia are actually more attractive that in 2019. In Europe the situation is different as long-term interest rates have had little room to go lower.
• There has been a sharp rise in ratings downgrades since the height of the pandemic. However, the increased support by central banks is helping stem this tide. The new issue market has surged with funding costs at significantly reduced levels. Consequently, balance sheet liquidity has significantly improved for many of these companies. This continues to drive a fall in credit risk premia. Nonetheless, downgrade and default risk is likely to remain elevated for smaller and high-yield companies.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk. riority50