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Sharpe Thinking: reflecting on four weeks of lockdown

What’s moving the investment landscape? In these turbulent markets, we bring you views from our portfolio managers, analysts and economists, delivered by our Investment Office – an independent body ensuring that our investment teams perform in the best interest of clients.

As we enter the first week of April, we reach a milestone of sorts. It is exactly four weeks since Italy imposed a country-wide shutdown, an unprecedented event that the rest of Europe soon followed. Evidence that the number of cases in Italy had started to plateau boosted markets this week, following a weekend where the caseload in the US mounted and the UK Prime Minister was hospitalised for coronavirus. Watch Aoifinn Devitt, Head of Investment - Ireland, discuss the events of the past week in this short clip.
 

 

US jobs data: a sorry sight

One of the most notable releases over the past week was the US payrolls numbers, which saw the cumulative number of extra unemployment benefit claims rise to 10m. Our Economics team believes this could lead to an unemployment rate of 13% by June.

Labour-market data are traditionally lagging indicators. This is clearly no longer the case, largely due to the widespread and sudden shutdown of the service and hospitality industries. It could be that the lack of historic precedent for these numbers has rendered them an anomaly, or markets may already have discounted some of the shock factor – something suggested by the market gains at the start of this week.

Central banks: easier ever after

Our Economics team has updated its policy looseness analysis, which examines the likely impact of the $2.2trn fiscal stimulus package on the US budget deficit.  Based on their estimates, the headline deficit is now likely to balloon from 4.7% of GDP in 2019 to 13.4% by 2021.

Combined with ultra-low policy rates and quantitative easing (QE) this fiscal stimulus means that the US now has the loosest policy mix in 25 years (see figure 1). Given that stimulus has been largely made up of QE and debt, it is difficult to see how policies – particularly monetary – can start to normalise as the economy improves.

Figure 1. US policies – how loose can they go?

Source: Federated Hermes, as at April 2020.

Credit: fallen angels on the rise

Our Credit team notes that March was one of the largest months on record for new issuance, mostly in the form of investment-grade credit. Liquidity in fixed-income markets has started to improve, although it remains tighter than is typical. The VIX, a measure of volatility, has come down from the highs it reached at the start of last month, but remains elevated. This suggests that while short-term uncertainty remains, consensus is gathering around the longer-term picture.

Downgrades continue apace, resulting in a raft of “fallen angels” which have moved from investment grade to high-yield status. This has helped the global high-yield market’s credit quality improve to BB- for the first time on record. New issuance also continues within high yield, as issuers are unable to access their usual short-term commercial paper.

Equities: how is the crisis changing corporate behaviour?

Our European Equities team sits at the (current) epicentre of the coronavirus crisis. It has observed some peculiar stock and sector moves, as well as high volatility and low turnover. Most companies have no visibility about demand and are subject to dividend and buyback restrictions that are now spreading beyond banks to airlines, hospitality, retail and energy firms.1 According to ICE data services, over 500 companies cancelled their dividend last month.2

In recent weeks we have seen examples of equity raising by European companies, as well as an increase in companies demonstrating their commitment to corporate citizenship. Last week, a UK-listed energy firm announced it would impose a moratorium on coronavirus-related lay-offs, provide free fuel for emergency vehicles and divert supplies used to make ethanol to sanitiser production. In addition, it plans to donate protective equipment to healthcare workers and give food from the firm’s closed cafeterias to foodbanks.

This compassionate corporate behavior can also be seen in Asia, where our Global Emerging Markets team notes that an Indian IT company recently set up a coronavirus-integrated control centre in the space of 72 hours. This aims to respond to citizens’ queries about the coronavirus, follow up on all cases of foreign returns and facilitate the mobile tracking of quarantine cases.

Meanwhile, our Global Equities team is examining the impact of the virus on both supply and demand and anticipates that there will be lower consumption and poorer consumer sentiment going forward. The team focuses on companies with sustainable business models: currently, it is looking for firms that are adapting well to the current crisis and searching for business opportunities to exploit.

Finally, our US Equities team expects that subsiding equity volatility is likely to have ramifications for corporate debt, with a likely pickup in defaults. Given that the problem has not originated in banks – unlike in 2008 – the team thinks that investors will be acutely focused on how banks approach the crisis. We will be watching to see if banks work with borrowers to ensure the ongoing provision of credit or provide flexibility around current lending terms.

  1. 1‘Canceled stock buybacks mount, and they may not return for years’, published by Bloomberg on 23 March 2020.
  2. 2‘Dividends Slashed as Companies Conserve Cash’, published by Investopedia on 2 April 2020.

For information purposes only. This is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Figures, unless otherwise indicated, are sourced from Federated Hermes.

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