Central banks: doing whatever it takes?
This week began with an unprecedented and – in the end – coordinated move from central banks to mitigate the impact of the spread of COVID-19, as the number of global cases rose above 200,000 and deaths exceeded 8,000.
This continued all week, as the Federal Reserve and the White House announced a $850bn stimulus package and considered direct payments to US citizens. Across the pond, the European Central Bank (ECB) launched the €750bn Pandemic Emergency Purchase Program to shore up corporate and government debt, as President Christine Lagarde stated there were “no limits” in the ECB’s commitment to the euro.
Our Economics team notes that while the actions of central banks have been spirited, with interest rates now close to zero they have largely run out of ammunition. As we saw this week, policymakers are now at the point where they have to try something different, such as purchasing corporate bonds or allowing greater fiscal looseness. To read more of the team’s views, see our latest Economic Outlook.
The S&P 500’s plunge from its record high on February 19 to a bear market 16 days later is the fastest on record. Our Federated Hermes colleagues in Pittsburgh believe that markets are “plumbing for a bottom” and are trying to price in a worst-case scenario, which is challenging given the prevailing uncertainty. While most economic data are largely irrelevant at this stage, our US strategists argue that we entered this “valley” of a market correction in a stronger position than in 2008.
Global Emerging Markets: long-term growth trends prevail
Our Global Emerging Markets team notes that healthcare, utilities, consumer staples have performed well recently, while cyclical names have suffered. Financial firms have experienced similar moves, notwithstanding the fact that they have been subject to rigorous stress tests (in anticipation of a crisis like this) for the past 10 years.
Nonetheless, structural growth rates in sectors like technology remain intact and may even have been strengthened by the virus. The news from China is positive, as major investment projects resume and over 90% of large-scale industrial companies in regions outside Hubei – where the coronavirus epidemic started – have restarted production. Growth remains subdued and Chinese GDP is set to shrink in the first quarter and should expand by far less than 6% this year.
SDG Engagement Equity: ‘decent work’ during the crisis
The Covid-19 pandemic means that many employers – particularly those working in industries like hospitality – are being forced to save on immediate costs and lay off workers. Earlier this week, Bank of England Governor Andrew Bailey highlighted how dire the situation has become, asking UK companies to “stop, look at what’s available, come and talk to us [or] the government” before cutting staff.
Our SDG Equity Engagement team believes that ‘decent work’, or Sustainable Development Goal 8, is inextricably linked to the other goals (read more about this in our series on decent work). To this end, it engages with companies to improve their hiring and workplace practices with a particular focus on those with high labour costs and low-pay business models. The strategy promotes the ability of companies to support the economic and mental wellbeing of employees, both of which may be at risk.
In these unprecedented times, it is important that businesses adapt their HR policies to ensure that sick leave is paid and that vulnerable employees do not come to work. We encourage firms to use the Opportunity Navigator tool – something we have shared with many of our portfolio companies in the past – which allows HR teams to measure their policies against examples of best practice.
Overall, we believe that this challenging period could present an opportunity to adapt practices in order to support employees and protect their economic and mental wellbeing.
Impact Opportunities: investing in long-term, prevailing themes
Our Impact Opportunities team believes that while the effect of the market drawdown on businesses is yet to be fully understood, the indiscriminate sell-off has created opportunities to buy companies at attractive valuations.
The team targets companies that provide innovative solutions to society’s pressing needs. It has an overweight exposure to healthcare companies, almost a third of which are ‘a-cyclical’ impact enablers that have long-term contracts and a focus on non-elective procedures. The strategy’s exposure to firms that produce essential products like insulin should help it defends its performance during the market shock.
Credit: a focus on liquidity
Our Credit team remains cautiously positioned in the auto parts, auto rentals and commodity chemicals sectors. Within energy, it is focused on higher-quality midstream issuers which have the flexibility to reduce distributions to shareholders in order maintain liquidity, as well as the lowest-cost oil and gas producers that have hedges in place and high-quality acreage.
Within our flexible credit strategies, we have tactically reduced our short positions and continue to look for opportunities where prices are dislocated. For example, the superior liquidity of BB-rated issuers mean their price has fallen more than lower-quality names (read more about this in our Weekly Credit Insight).
Structured credit: starting to respond to market moves
Our Fixed Income team noticed some liquidity blockages in structured credit markets last week. In particular, there were few motivated sellers of collaterised-loan obligations (CLOs) at the prevailing bids. This soon shifted, as CLOs started to react to the wider market moves and became more closely aligned with the fallout in high-yield credit.
The asset-backed securities (ABS) market continues to hold firm, with low issuance and little liquidity. This means that while CLO spreads have moved wider, the ABS market is more opaque. However, as managers endeavour to meet redemption requests we expect to see more sellers, a greater number of trades and more accurate marks.
Real estate debt: an uncertain outlook
Our Real Estate Debt team comments that in normal market circumstances, the obligation to pay rent tends to survive market turmoil. However, the current situation will hit operational businesses like hotels, restaurants and flexible office providers. As they generate income on a daily, overnight or monthly basis, a demand shock will immediately hit the bottom line.
The same will shortly be true for retailers, where in some cases there will be no basis for even claiming rent. This can be seen in the US, where Simon Property recently shut shopping centres. It is very likely that a period of rent forgiveness and covenant renegotiation lies ahead.