With emerging markets still driving the global caseload of COVID-19, now at eight million, there is reason for concern.
- Countries such as Brazil, Mexico, India, Indonesia and South Africa often have a more limited primary healthcare capacity to deal with a surge in acute cases.
- Furthermore, the relatively crude public health response that the advanced economies deployed – locking down society – is often impractical in these countries given their greater reliance on the informal economy.
However, the market focus remains on developments in the world’s two economic superpowers.
- In the US, the number of new daily cases has remained stable at around 20 000 for the past three weeks. However, at the state level, the picture is more complex: there are worrying trends in new cases in the south and the west and reports of more COVID hospitalisations in 14 states since Memorial Day. Houston – the fourth largest US city – is a particular cause for concern. Officials declared ‘code orange’, meaning uncontrolled transmission of the disease.
- China saw another reminder of the need for constant vigilance with a spike in cases driven by what looks like a local outbreak in Beijing where more than 100 cases have now been confirmed. The authorities have responded rapidly: plans to reopen schools were cancelled, wholesale markets were closed, movie theatres and karaoke rooms will remain shut, group meals in restaurants are banned and all sports events were put on hold. If it was not clear already, this illustrates the painful and patient ‘two steps forward, one step back’ reality of exit.
Emerging from lockdown: On what grounds?
Exit from lockdown and easing of social distancing is underway in a large number of countries. We are concerned that the scientific criteria that were established to guide this process have not been satisfied convincingly.
The effective reproduction number R(t), which describes the extent to which the authorities have the disease under control, points to a fairly tame drop-off.
Professor Matt Keeling at the University of Warwick summarised the situation across UK regions as follows: “All the ranges are closer to the critical threshold than we would ideally like to see – which means that the epidemic is declining relatively slowly. This also means we haven’t got much wiggle room for additional relaxation of social distancing measures.”
The picture on testing and tracing is also mixed, with the Oxford COVID-19 Government Response Tracker showing a clear variation in countries’ capacity to implement this critical weapon against COVID-19 outside of lockdown. In short, we are worried about the risk of a second wave.
US economy: bouncing back
This week saw more evidence that the US economy is bouncing back faster than expected with retail sales data increasing by almost 18% in May. This was far ahead of market expectations and unwound the lion’s share of the decline in April. The data pointed to a shift in behaviour that may persist beyond the pandemic period: online shopping is up by almost 30% on the year.
As with the recent upside surprise on the jobs numbers, we worry that you can have too much of a good thing: if the economy is recovering faster than expected, social distancing is likely collapsing faster than expected and the risks of a second wave are likely rising too.
Monetary policy: a dovish message from the Fed
On the policy front, the latest FOMC policy meeting signalled the pace of asset purchases can rise in response to financial conditions tightening: the Federal Reserve will continue buying government securities and agency debt at least at the current pace to ‘sustain smooth market functioning’.
Central bankers also flagged through the ‘dot plot’ that US interest rates are likely to be unchanged at least until the end of 2022. One could argue that rates are likely to stay this low for considerably longer with the jobless rate still expected to be far from the equilibrium rate in two years’ time and inflation not approaching 2%.
Fed Chair Powell was clear that the US economy had not generated significant inflationary pressure when the unemployment rate had been at historic lows before the crisis, so we are sceptical that the FOMC will raise rates before it has more or less restored full employment.
The Federal Reserve also published details on the securities that it will buy under one of the main credit programmes. The Secondary Market Corporate Credit Facility (SMCCF) will purchase individual securities to create a portfolio that is broadly representative of the outstanding bonds in the secondary market, subject to key criteria –
- US companies have issued the bonds
- The bonds satisfy a minimum credit rating (rated at least BBB-/Baa3 as of 22 March 2020, and if subsequently downgraded, at least BB-/Ba3 on the date or purchase)
- The bonds have a maximum residual maturity of five years.
Market outlook: a brighter picture
- As lockdowns are lifted, sentiment indicators are picking up. Industrial production and retail sales have rebounded in the US (see above) and to a lesser extent in China. Europe and the UK have lagged, but we believe data will improve in parallel with the easing of lockdown measures.
- US stimulus measures continue to support markets and are expected to last into the summer, keeping the market recovery on track. The Fed’s move to broaden the terms of its corporate bond purchases, has led to a surge in demand for both investment-grade and high-yield bonds and has halted the risk-off mood in markets.
- US financial conditions eased further. In Europe, they are more restrictive, but they too are easing, albeit slowly. Fed comments about rates staying low until 2022 ensure US financial conditions will remain accommodative. This is positive for the US economy and markets.
- Flows into riskier assets are improving (e.g. into emerging market bond funds and high-yield). Investors markedly prefer spread products, especially US corporate bonds. This is narrowing risk premiums and should support a gradual recovery in volatility markets. In equities, investors have been rotating out of more defensive sectors into cyclical higher-beta sectors and small caps. This should support the broader markets that have lagged the recovery in technology stocks.
- Central bank support and the fiscal backstop are underpinning the valuations of global equities, credit and emerging markets. Given the FOMC’s dovish guidance, the USD may weaken and the US yield curve may steepen. In Europe, the latest Dutch pension fund reforms point to a steepening of the European swap curve.
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.