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COVID-19 Impact Across Markets

Highlights from the Global Research team on the implications of COVID-19 for the global economic and markets outlook. Each week, we will feature the key reports published.

Updated: July 15, 2020

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Cross-Asset Views

Pandemic Accelerates Paradigm Shifts

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.

Merits of Underweighting U.S. Assets in Global Portfolios

John Normand

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.

Global Asset Allocation: Staying Pro-Risk, Adding Back to Equity OW

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.

The Reopening Continues Despite Second Wave Risk

Introducing a Second Wave Risk Screen

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.

COVID-19 in Europe

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.

U.S. Insurance COVID-19 Tracker

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).

Global Economics and Macro Implications of COVID-19

You Can't Always Get What You Need

Bruce Kasman

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.

Global Consumer Surge Leads Recovery

Joseph Lupton

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.

What the PPPLF Says About the MSLP

Michael Feroli

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.

This Time It's Different

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.

Market Implications of COVID-19

Market Valuations, Positioning and Potential for a Value Rally

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.

U.S. Election Implications for Equities, Democrat Agenda Winners and Losers

Dubravko Lakos-Bujas

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.

Wide Trading Issuers May Look Past Potential Stigma if They can Fund Inside Secondary Spreads

Eric Beinstein

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.

Euro Rates Liquidity, Sentiment and Risk-Off Indicators

Fabio Bassi

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.

Sector Level Views

With Parks Reopening, Where Does Disney Go From Here?

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.

ESG Wire: Research Highlights

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).

Electric Vehicles Deep-Dive: European focus

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.

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