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Cycles in the time of Covid-19

Coronavirus_newspapersHow to invest in a time of Covid-19 is a question that affects us all. In this webinar, Mathieu Savary, strategist at BCA Research, joined Funds Europe’s contributing editor, Fiona Rintoul, to discuss the outlook for the global economy and for different asset classes in the wake of Covid-19.

The global economy is expected to contract at its fastest pace since the 1930s, but it isn’t all gloom and doom. Mathieu Savary, who works on BCA Research’s Bank Credit Analyst publication, which has been published continuously since 1949 and likes to challenge investment convictions, began by explaining why he does not expect the global economy to slump into a depression.

“This shock is very different from the one that caused the Great Depression, the global financial crisis or most recessions,” he said. “It’s a traditional exogenus shock. When we look at pandemics, there is a sharp contraction in GDP growth, but it tends to be short-lived and ultimately the economy recovers quite quickly afterwards.”

Savary went on to explain that the kinds of imbalances in the economy that typically presage a long depression are not present. There is a lot of pent-up demand. With households still able to take advantage of low interest rates, they are likely to delay rather than cancel purchases of durable goods, which could mean a pick-up in Q4 2020 and Q1 2021. The experience of China, which entered and ended lockdown ahead of other countries, provides an instructive example.

“What we saw there was a sharp rebound in the PMI, industrial production and domestic orders, and other economies seem to be following a similar path,” Mathieu said.

Another factor is the €9 trillion output gap that will develop because of Covid-19, which signals muted inflation pressure. This in turn will allow policy makers to be accommodating.

So far, monetary policy makers have been aggressive, with the Federal Reserve (Fed) and the European Central Bank expanding their quantitative easing (QE) programmes and lending to the private sector. As Savary explained, this stance was driven not just by low demand and inflation expectations, but also by a developing liquidity crisis, which could have pushed companies into default. With the economy still fragile and little inflationary pressure, central banks will continue their easy policy.

“They don’t want to take any deflationary risk,” Mathieu said. “Therefore, they will keep monetary policy at the most accommodative levels we’ve pretty much ever seen for at least 24 months if not more, if inflation remains low.”

Loose monetary policy is accompanied by record fiscal easing. For a range of leading countries, fiscal stimulus as a percent of GDP was much higher in 2020 than it was in 2008-10. In the US, total additional spending could reach the “stunning number” of $4-5 trillion – and the figures do not even include loan guarantees.

“The regime of loan forebearance that is being put in place around the world means that companies and households can avoid default for an extended period of time,” said Savary.

Meanwhile, the People’s Bank of China has cut its interest rate on excess reserves, which presaged a surge in Chinese credit the last time it happened. Stimulus in the Chinese economy will be an important component in the revival of industrial activity in the global economy as we move beyond the pandemic, in Savary’s view. That global economic revival will also be facilitated by banks and households that are in much better shape than they were in 2008.

Before moving on to hear Savary’s views on individual asset classes, we polled the webinar audience to discover their preferred asset classes and their assessment of the US dollar. On the US dollar, the audience was pessimistic with 43% expecting it to have depreciated by more than 7% by the end of year. The audience also gave government bonds a thumbs down, with no one choosing them as their preferred asset class for the remainder of 2020. Instead, the audience favoured US stocks (32%), credit (28%), European and Japanese stocks (26%) and emerging-markets stocks (13%).

On the US dollar, Savary tended to agree more with the audience than with his North American clients, who are often bullish on the dollar. The US’s widening twin fiscal and current account deficits are a worry, and dollar purchases don’t necessarily herald international confidence.

“When we look at flows inside the US, the big purchases in recent months have been American citizens themselves,” he said. He added that as a counter-cyclical currency, the US dollar will benefit less than other currencies when the global industrial cycle picks up, as he expects it to do in the second half of the year.

On government bonds, Savary was also in concert with the audience. “I can’t blame people for not liking govvies,” he said, highlighting low yields, high issuance and other longer-term problems.

“With all the monetary and fiscal stimulus that we are enacting to deal with the shock created by the lockdown and the virus, I think we are playing with fire in terms of generating inflation on a long-term basis.”

Mathieu also described government bonds as “furiously expensive”. They are at their most expensive level since 2009 and prior to that you must go back to 1985 to find such overvaluations. Furthermore, with QE lifting yields but also breakevens, Savary expressed a preference for TIPS and index-linkers.

A question from the audience, asking how Savary explained the apparent dislocation between stock markets and the economy and whether he expected stock markets to revisit the lows of March, introduced the topic of equities. Savary averred that high stock-market valuation levels were not due to investor exuberance but to extraordinarily low yields. Furthermore, sector analysis shows that the dislocation with the economy is not so very great.

“Cyclicals relative to defensive have been extremely weak, and historically they have tracked the situation with economic activity much more closely than the aggregate level of the stock market,” he said, meanwhile tracing dynamism in growth stocks back to yields.

Citing the old Wall Street adage “don’t fight the Fed”, Savary added that he did not expect valuations to sink back to March levels. Instead, with the median stock still oversold, he expects stock markets to churn over the summer.

“We think that the easy gains in the stock market are behind us,” he said. “But being too bearish is a dangerous stance to take when global monetary and fiscal policy is as easy as it is today.”

Finally, on a sector view, Savary  saw an opportunity in the heavily punished energy sector, while placing a question mark over the tech darlings. Extreme cheapness and a “strong supply response” in the energy sector mean it is at the very least worth a look, he said.

“On certain matrixes, such as price-to-book, energy might be the cheapest it has been since the 1920s.”

You can watch the recorded 'Cycles in the time of Covid-19' webinar on the Funds Europe's webinar channel.

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