We are now around two months since major stock indices in the US and down under reached all- time highs. What has happened since then doesn’t need too much revisiting: more than 1 million COVID-19 (coronavirus) cases, coming up 80,000 deaths across more than 200 countries. The coronavirus, ostensibly, brought the global economy to a near standstill.
It’s difficult to assess where the end is from a time perspective. The peak or ‘flattening of the curve’ will vary on location and societal behaviours. There is now strong evidence that ‘shelter in place’ does, in fact, flatten the curve earlier than prior analysis indicated, but to what extent and when is best left to the doctors, epidemiologists and other specialists.
However, as an investment manager, especially an active manager, our role is to assess the economic data and characteristics ahead of us. And these will determine how we see the global economy and financial markets responding to the recovery.
What do we know?
We know policy response has been unprecedented, and significant. How effective, we won’t know for a while, but it’s been relatively swift and large. On 26 March, the G-20 leaders said they are injecting $5 trillion into the global economy.
We have seen a rebound in Chinese business activity and anecdotal evidence of a pickup in resource demand and commuter travel. However, this one comes with a caveat; is it a post lockdown bounce or the beginning of a gradual return to the norm?
And we are seeing billions of dollars being poured into medical advancements to combat the virus.
Now, what will the recovery look like?
Given what we have seen, socially, economically and politically, we have formulated three scenarios for how global markets exit this sharp slowdown in economic growth.
Our base case: Our base case is a U-shaped recovery. We will see a lockdown period of one to two months, which will ‘flatten the curve’ of coronavirus cases and the measures to prevent a second outbreak will be more than manageable. By this time, we would expect to see economic activity return to 70%–80% of previous levels by the end of the year.
U-shaped recoveries are characterised by a sharp decline in global growth and an increase in unemployment. We have begun to see the employment situation worsen in the US with around 10 million Americans filing for unemployment benefits over the two-week period ending 29 March.
Our bull case: Our bull case hinges on medical advancements in the form of treatments or a vaccine. If we see either of these materialise over the next few months we could see a V-shaped recovery where the economic and social situation rebounds sharply and back towards pre-virus levels.
While medical professionals are working around the clock and we are seeing advancements with Phase 3 trials for existing drugs and Phase 1 for vaccines, lab to distribution can run into political and regulatory hurdles.
Our bear case: This would be evident by repeated shutdowns on the back of multiple waves of reinfection. This L-shaped recovery would be a long period of economic depression, resulting in prolonged high unemployment, subdued consumer confidence and business bankruptcies as global demand for products and services remains low.
So where does that leave us?
Given what we have laid out, we are neutral on both domestic and international equities. Even though global equities are cheap on a valuation basis, we are acutely aware this does not mean that the worst is behind us. Furthermore, any path to recovery will be rough and face significant challenges.
And down under, New Zealand and Australia’s exposure to China remains of significant concern to the economies given their reliance on Chinese demand and tourism.
We are also neutral on real assets, including infrastructure and listed property. Listed property tends to outperform in a low-interest-rate environment, but the sharp economic downturn has increased the probability of missed rent payments or renegotiations. In saying this, we believe investors will still find quality assets in good locations attractive investments.
Finally, perhaps best reflecting our view is our overweight position to cash. With equities having fallen as much as 30%, we are confident opportunities will present themselves over the short to medium-term. And as an active manager, holding this cash will allow us to capitalise on any opportunities that present themselves.
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