Investment Commentary and Outlook as of May 14th
This is the next installment of our series that addresses the effects of the COVID-19 pandemic on economic markets and our views on how markets will recover. We have been releasing these updates approximately every ten days, but now that the worst is over (hopefully) we will be scaling back the frequency of these updates.
What we are seeing on the virus front:
- Many countries, including much of Europe, are getting their outbreaks under control and are slowly re-opening some activities
- There are also some countries, especially in emerging markets, where case numbers are still growing fast
- The US remains a mixed bag – case growth has declined sharply in some areas, but cases are rising in others, even in some places that are re-opening
- A number of countries have demonstrated that case growth of almost zero with broad re-opening is possible with aggressive mitigation measures: South Korea, China, Taiwan, Australia and New Zealand are examples
- Testing capacity has increased everywhere, but remains lower than experts say is necessary to support ongoing mitigation strategies such as “test, trace and isolate” in many places
What We Are Watching
April was an excellent month for stocks as investors cheered all of the support that central banks and governments are providing. The total value of the support, both fiscal and monetary, is close to the total amount of income that is expected to be lost: the central banks and governments are “filling the hole” reasonably well at an aggregate level (combined rescue packages total >15% of global GDP). Our concerns are more focused on areas that the rescue packages may miss and whether the GDP “hole” ends up being larger than many currently anticipate. While we do not doubt the resolve of central banks and governments to keep doing what they need to do to fill holes as they appear, these programs will never be as efficient as the GDP that was lost and we worry about the long term implications on economic growth of these extreme levels of government support.
Two reasons that the GDP losses could end up larger than what is currently forecast is that moves to re-open economies lead to renewed fast case growth, and/or that removing government-mandated restrictions doesn’t do much economically as people still decide to mostly avoid places where people might congregate. Our position remains that in order to re-open successfully, governments will need to implement effective virus control measures, such as “test/trace/isolate” which helps to keep actual case numbers down and, just as importantly, gives people confidence that case numbers can be low enough for them to be safe enough to return to something that looks like normal activity. If a government does not mitigate effectively after a shutdown, then the likelihood is that the outbreak resumes in a few weeks and a new lockdown will have to begin. The other alternatives include (1) letting the virus run its course and (2) maintaining heavy social distancing until a vaccine is in-place. Both of these options are likely to lead to worse economic outcomes compared with an effective mitigation program.
Even with effective test/trace/isolate mitigation programs (and almost universal mask wearing) as we see in China and South Korea, we still see populations that are nervous about getting back to normal. We also see international travel in particular at extremely low levels. Massively reduced travel is likely to be with us through the balance of 2020. We continue to have a “U-shaped” economic recovery as our base case, and are hopeful that we can avoid a “W-shaped” recovery characterized by renewed outbreaks leading to renewed lockdowns and additional economic downturn.
We also note that we have seen the first positive news on the treatment front as remdesivir has been approved for use by the FDA. We are optimistic that this is the first of what we hope will be many treatments for the worst effects of the disease – there are many drugs in the development pipeline. However, neither remdesivir nor other treatments in the pipeline are likely to be silver bullets given the nature of viruses and how they impact the body – a vaccine is still much more likely to provide the ultimate relief we need to return to full normality.
We continue to have concerns about how certain countries and populations within countries will be able to handle the long-term impact of this event. For example, without national (and ideally, international) case numbers at very low levels and therefore with people confident enough to fly, how is Las Vegas going to be anything other than a city where the majority of people have to live on unemployment or Social Security checks? Mexico, Thailand, Caribbean countries and many others are all in the same predicament. The fallout from the collapse in global tourism has not yet been fully processed by markets.
How Are We Positioned?
We have continued to selectively add higher-risk assets to portfolios, with a focus on those areas of the credit markets that are being directly supported by central bank programs. We are working with clients for whom it is appropriate to make investments in the Term Asset-Backed Securities Loan Facility (TALF) program. We are also utilizing the equity option markets to position clients to take more risk, but in a controlled manner, as these tools allow us to precisely shape a range of outcomes over a given time horizon.
We see lots of progress on the virus control front, but also some worrying signs that we may lose control again in some places. The response of governments and central banks to mass unemployment and loss of revenue has been relatively promising, but we risk that the relief ends up in the “wrong” places, leading to a very uneven recovery. Markets reflect this, with widely diverging valuations between companies, sectors and countries.
To discuss your current situations with our team of experts contact us at USA@riverandmercantile.com