Updated: July 15, 2020
Joyce Chang and Jan Loeys
While there is a temptation to point to the COVID-19 crisis as new and unprecedented, we view COVID-19 as an accelerant, amplifying paradigm shifts that were already in motion. The decline in market liquidity is likely a permanent shift as market depth for equities remains 60% below pre-pandemic levels, despite G-4 central banks embracing unconventional policy measures and expanding balance sheets by ~20%-pts of GDP over the past 3 months. A more expansive political debate on the role of monetary policy is here to stay and $32trn+ of DM government debt, or 69% of the total public sector debt stock, now yields 0.5% or less. The re-escalation of U.S.-China tensions will not be met with decoupling but “coopetition,” where the U.S. and China selectively cooperate or compete based on national interests. De-globalization is a policy choice and not a pre-ordained outcome, with the appeal of populists actually declining during the pandemic. For the new decade, early signs are that we will see a modest but uneven pace of de-globalization.
Aside from Tech and Chinese stocks, most markets are failing to make new price highs and spread lows given the conflict between a booming global economy and rising COVID-19 infection rates in some areas. The U.S. is the only economy now at the intersection of a second wave and political risk, which is why investors often ask whether U.S. Equities and the dollar should be underweighted in global portfolios now. This view ignores details, like the growth cushion in the U.S., the fullness of the Biden platform, and the drivers of relative Equity and FX performance. Rather than underweighting U.S. assets broadly, there is better risk-reward in owning Tech/Quality to hedge the second wave, only favoring North Asian Equities and FX to hedge the virus plus a Democratic sweep, or just staying long Gold.
Marko Kolanovic, PhD, Nikolaos Panigirtzoglou, John Normand, Bram Kaplan, CFA
This month, we shifted some of our risk from credit to equities, reversing last month’s portfolio adjustments, as positioning and relative value provides stronger support for equities, and near-term political/geopolitical risks appear to have receded. Equities are cheap relative to bonds, trading in their ~15th percentile on relative valuation based on an equity risk premium framework. This valuation dislocation is a direct result of policy actions that pushed bond yields lower, i.e., central banks cutting short term rates to zero, and purchasing of interest rate and credit instruments. Equities are also under-owned by macro and systematic investors, who are likely to re-lever as market volatility declines.
MW Kim and Ling Wang
We introduce an infection risk matrix screening the risk level of infection resurgence in major EM/DM countries. The global infection tally is ~12.3M with a 4.5% mortality rate. Latin America countries contribute ~1/4 of total infections following the rise in infections. Post re-opening, we see “no” risk-free next step. Considering the cost/benefit, in our view, reducing social interactions could remain a highly recommended measure.
Richard Vosser and Ashik Musaddi, CFA
EU five weekly new infections continued to decline and although the absolute level is still low, increasing case counts in a number of countries could become concerning and require further lock lockdowns. Germany’s new infections continue to decline by 20%. Italy and the U.K. weekly infections continue to decline by 11% and 30%, respectively. However, Spain’s and France’s cases rose by 9% and 16%, respectively, if the data for the first 5 days for the week are analyzed. Cases continue to rise in Austria and Switzerland.
Jimmy S. Bhullar, CFA
U.S. daily infections have been rising and could drive an uptick in deaths as well, which have declined significantly from the peak level in April. Cases have dropped in the Northeast, but rising in CA, FL, and TX and most of the South. We expect life insurers to incur modest direct losses from the virus, but a further uptick in deaths is an incremental risk. Virus-related claims for P&C firms should be manageable as well, other than for business interruption. While considering the impacts of COVID-19, we are most concerned about the credit market, which affects life and P&C insurers (although P&C firms are less susceptible given their lower asset leverage).
The COVID-19 pandemic and policy response are generating the most dramatic and synchronized growth swing in history. All 39 countries we follow fell into recession, and we project global GDP plunged 16% ar in 1H20. Re-opening alongside temporary credit and income supports is sparking a consumer-led mid-year bounce that we anticipate will generate 20% ar growth in 2H20. Global GDP is still projected to fall short of a complete recovery owing to private sector caution, impaired balance sheets, and early removal of fiscal support. Relative to its pre-pandemic path, we forecast global GDP will be 3.6% lower at the end of 2021. Re-openings before the virus is controlled and the absence of globally coordinated controls suggest the initial growth bounce will fade as consumers remain cautious and cross-border activity remains restricted. Economic policy has successfully supported credit and income growth through the crisis. These emergency measures will soon expire. After boosting global GDP by 3.5% in 2020, global fiscal policy is expected take 1.6%-pts off growth in 2021.
The global recovery is beginning with a surge in consumer spending. Unprecedented policy supports have significantly offset labor income losses. This is interacting with the reopening of marketplaces and significant pent-up demand to generate record gains in spending, albeit from extremely depressed levels. Mobility data imply a 10% surge in global retail sales in June, returning spending to pre-pandemic level.
The Fed’s Main Street Lending Program (MSLP) is intended to be a cornerstone of the federal government’s efforts to support small- and medium-size enterprises (SMEs) during the pandemic. In its bare essentials, the MSLP is a Fed-sponsored vehicle which offers to buy from banks 95% of their new loans to SMEs. This should support bank lending to SMEs if (a) banks face challenges funding their balance sheets, or if (b) banks face regulatory constraints on the size of their balance sheets. However, the MSLP does nothing to alleviate concerns banks may have about the creditworthiness of such loans: banks’ 5% share of MSLP loans take credit losses pari passu with the MSLP. This is in contrast to the Paycheck Protection Program (PPP). In short, in the PPP, the government assumed all of the credit risk of the loans that banks made to small businesses. Bank participation in PPP was not a problem; in fact, banks lent out the first allocation of PPP loans so quickly that Congress chose to authorize another allocation.
Nora Szentivanyi and Jahangir Aziz
This crisis is not typical of EM as it wasn’t caused by balance-sheet excesses and overheating. The policy response therefore needs to be different from the past. In other words, this is not an instance of a financial crisis turning into an economic shock because of damaged balance-sheets. Instead, this is a case of an economic shock that could turn into a financial crisis and delay the recovery if damaged balance-sheets are not repaired. Fiscal tightening on perceived fears of instability could backfire if it hurts medium-term growth. Supporting growth is more likely to improve medium-term debt dynamics than rapid fiscal consolidation.
Marko Kolanovic, PhD
We think the recent equity rally can continue because of a valuation shift, inflows from retail investors, and most importantly because positioning of hedge funds and quantitative investors is still very low. Low positioning is a result of high macro uncertainty and market volatility. If the macro and market volatility can decline (e.g., VIX stays in the 20s during the summer), these investors will be pulled into the market.
The consensus view is that a Democrat victory in November will be a negative for equities. However, we see this outcome as neutral to slight positive. Given current economic weakness, business recovery and job growth are likely to be prioritized over policies that could dampen economic growth and perhaps even jeopardize the desired 2022 midterm election outcome. As such, the degree of corporate tax reversal may ultimately be lower than currently discussed (i.e. <28% ). Other policy proposals including infrastructure spending, softening tariff rhetoric and higher wages should be net positive for S&P 500 earnings and largely offset the corporate tax headwind. Further, a more diplomatic approach to domestic / foreign policy will likely result in lower equity volatility and risk premia.
The Fed formally launched its Primary Market Corporate Credit Facility (PMCCF) with a cap on spreads on new issues under the program—a key change of little consequence today with spreads within 60bp of pre-COVID tights, but could easily become significant again in a ‘second wave’ scenario and/or if we get more issuer differentiation post-Q2 earnings. The combination of PMCCF and SMCCF is a powerful official endorsement of the goal of keeping the HG bond market stable and the costs of borrowing contained (within limits). However, it remains to be seen how many companies will be willing to ask for government funding at the risk of potentially being subject to further scrutiny down the road, especially heading into a pivotal election. While the step of certifying “Solvency and Lack of Adequate Credit” to access PMCFF may carry some stigma, there is now a rational economic reason for an issuer to consider bearing that stigma in exchange for the option to issue inside of its secondary spreads.
A further $23bn of the 84D USD bilateral facility of the Fed with DM central banks has rolled-off, bringing the cumulative roll off over the past five weeks to ~$281bn with another $24bn (of which $21bn with the BoJ) of cumulative 3M borrowing to mature in the coming week. The total outstanding borrowings in the USD bilateral facility has now declined to around $134bn with most of the borrowings now done via term (around 85% in 84D operations), and over 80% with the BoJ only. Looking at the June TLTRO III borrowing Italian and Spanish banks have borrowed around €133bn. While all national central banks have not yet released their balance sheet snap for the month of June, given the net uptake at the Jun20 TLTRO III operation was around €550bn, we estimate that around €400bn of take-up was coming by core banks.
Alexia S. Quadrani
The reopening of Disney parks globally is a critical sign of recovery as this removes the largest overhang at the company due to COVID-19. With all of the parks’ reopening dates now set with the exception of Disneyland in Anaheim, we explore where the stock will go from here. We remain Overweight and have increasing conviction that the health of the company is returning throughout several of its segments, with a move toward profitability in F23 at Disney+, the reopening of the parks, and the return of live sports.
Jean-Xavier Hecker, Hugo Dubourg
The EU published on Wednesday, July 8th, two strategies that will contribute to the achievement of its 2050 Carbon Neutrality goal, by transitioning the existing energy system into a more interconnected and decarbonized one. The first strategy is the Hydrogen Strategy, which focuses on giving a boost to clean hydrogen production in Europe, as well as developing demand for clean hydrogen across sectors. The second strategy is the EU Strategy For Energy System Integration, which aims at deconstructing silos of the energy value chain and infrastructure across end-use sectors (transport, industry, gas and buildings).
Jose M. Asumendi
Implementation of stimulus packages in Europe have led to sharp increases in BEV and PHEV volumes, particularly across Germany and France. In June’20, 59.5k xEVs were sold in the big 5 EU countries (up 122% m/m) hitting all-time highs, and in Q2, penetration of xEVs expanded to 7.3% vs 6.4% in Q1 and 2.5% in FY19. We expect this momentum to accelerate going into 2H20 and 2021, boosted by a robust EV launch calendar and supportive government policies, which seem likely to be extended beyond the current mandate, thereby enabling OEMs to generate demand to meet their 2020/21 CO2 targets.
This communication is provided for information purposes only. Please read J.P. Morgan research reports related to its contents for more information, including important disclosures. JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively, J.P. Morgan) normally make a market and trade as principal in securities, other financial products and other asset classes that may be discussed in this communication.
This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but J.P. Morgan does not warrant its completeness or accuracy except with respect to any disclosures relative to J.P. Morgan and/or its affiliates and an analyst's involvement with any company (or security, other financial product or other asset class) that may be the subject of this communication. Any opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This communication is not intended as an offer or solicitation for the purchase or sale of any financial instrument. J.P. Morgan Research does not provide individually tailored investment advice. Any opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. You must make your own independent decisions regarding any securities, financial instruments or strategies mentioned or related to the information herein. Periodic updates may be provided on companies, issuers or industries based on specific developments or announcements, market conditions or any other publicly available information. However, J.P. Morgan may be restricted from updating information contained in this communication for regulatory or other reasons. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.
This communication may not be redistributed or retransmitted, in whole or in part, or in any form or manner, without the express written consent of J.P. Morgan. Any unauthorized use or disclosure is prohibited. Receipt and review of this information constitutes your agreement not to redistribute or retransmit the contents and information contained in this communication without first obtaining express permission from an authorized officer of J.P. Morgan.
Copyright 2020 JPMorgan Chase & Co. All rights reserved.