A sense of optimism
May was another exceptionally strong month for global markets – particularly in the US. The S&P 500 rose by 7.55% over the month, while the NASDAQ delivered 10.28% (which pushed its year-to-date return into positive territory). This rosy investor sentiment was also apparent in market technicals, as the S&P 500 closed above 3,000 – and its 200-day moving average – for the first time since 4 March.
Bourses in Europe were more muted: the FTSE rose by 5.44% in May, while the Stoxx Europe 600 added 3%. In Asia, where the virus is essentially contained, Hong Kong’s Hang Seng index lost 6.8% – a clear reaction to political developments, after China approved a controversial new security law. The only exception to generally lacklustre Asian performance was in Japan, where the Nikkei 225 jumped 11.5% during May after the country ended its state of emergency.
This apparent normalisation could be attributed to declining coronavirus hospitalisations and deaths in Europe, while sentiment has also been buoyed by evidence that state intervention has successfully muted economic pain. Although US consumer spending fell by 13.6% in April, personal incomes rose by 10.5% – which prompted a member of the the Federal Reserve to suggest that the country was nearing the bottom of the economic downturn (although employment data is expected to deteriorate further before improving). The personal savings rate also rose to a record 33%, as a ‘work from home, buy from home, eat at home’ new reality set in and shops remained shuttered (see figure 1).
Figure 1. US savings tick up
Source: Bureau of Economic Analysis, as at June 2020.
This market strength could also be explained by the record amount of cash in money-market funds, which suggests that investors have been keeping some reserves on hand – and are now looking to pick up some bargains. This was accompanied by a flattening of the volatility curve, which is now dramatically lower than its mid-March peak – although still quite a bit higher than its holding pattern at the beginning of the year (see figure 2).
Figure 2. Volatility eases
Source: Bloomberg, Federated Hermes, as at June 2020.
Fixed income: moving towards the new normal
Our Credit team notes that there was an uptick in draws on revolving-credit facilities throughout May, as companies rushed to shore up cash flows. Meanwhile, ongoing monetary looseness also encouraged a spate of debt issuance from higher-quality companies, which was met with robust demand.
$1trn-worth of corporate bonds were issued over the five months to the end of May, including a significant portion in high yield. A near-record issuance of high-yield bonds in April – worth $38bn – means that the high-yield universe is now worth close to $1.2trn. The month also saw the highest-ever retail inflows into US high yield, which emphasises how attractive high-yield coupons are in an environment when equity dividends are in doubt.
The team also notes that the average credit quality of the asset class has increased, while the default rate is rising. BB-rated issues represented 60% of total high-yield volume during the first four months of the year, compared to only 42% a year ago. Meanwhile, the default rate is expected to rise to 5.5% – the highest since 2010. This is likely to be far higher in sectors like energy, where the default rate could reach 17% in 2020, and retail, where it is currently close to 10% but is expected to rise as high-profile bankruptcies mount.
Looking to private fixed-income markets, our Direct Lending team has noticed that the approach of private-equity sponsors to debt and covenant renegotiations has somewhat normalised as we move beyond the triage stage of the crisis. Up until now, significant forbearance has been shown and there has been an uptick in covenant amendment requests (see figure 3). Nonetheless, there is a growing sense that this grace period can’t last indefinitely.
Figure 3. Requests for covenant amendments in Europe soar
LCD, S&P Global Market Intelligence, as at 30 April 2020.
Real estate: light at the end of the tunnel?
Given the challenges associated with valuing properties, there is still poor visibility within real-estate markets. Nonetheless, there also seems to be an attempt to move beyond the current freeze and form positive collaborations between different parties.
For example, the UK government recently announced that it was working on a code of practice to provide clarity and reassurance to commercial landlords and tenants, recognising how the coronavirus shutdown has placed equal financial pressures on both groups. As lockdown restrictions are eased and the true shape of consumer demand and preferences emerge from the rubble, a positive commitment towards collaboration should aid the rehabilitation of the sector.