5 minute read.
March has been anything but typical. Jim McCormick outlines key themes that are rapidly shaping up to become the new normal for our global economy and financial markets.
Should we be risk-on or risk-off?
10 days ago, we shifted our view and went neutral on risk assets (such as equities). This was because we felt that the combination of modest recessionary pricing in asset markets and the size of the global policy bazooka would offset to some degree the likely negative shock to global growth from the coronavirus crisis. In the end, risk assets soared over the course of the week, led by US credit markets and to a lesser degree emerging market local rates. On Friday 27 March, the S&P500 weekly percent change was the largest since November 2008. Against that backdrop, the thought of shifting to a more risk-on appetite is enticing. All the same, neutral still looks reasonable.
Coronavirus impact – theme 1: Global policy continues
On policy, the week of 23 March was another very good one as the global policy bazooka got even larger and important details were further fleshed out by the US, the European Central Bank and Germany among others. This global policy framework should help weed out some of the market dysfunction we seeing from equities and fixed income assets, but until it is clearer how long the coronavirus economic shutdown will last. For more on this ready our takes on the global policy measures and the future of fixed income and equity returns.
Coronavirus impact – theme 2: The global growth shock
While on growth, the news in the past week painted a fairly dismal picture of the impact from the coronavirus crisis. For instance, the March flash Purchasing Managers Index (PMI) data implied a hit to global service sector growth at least as big as the one seen during the Global Financial Crisis. Meanwhile, US jobless claims data surged to an all-time-high, underscoring the uniqueness of the coronavirus crisis – never in modern memory has the global economy been hit with such an acute shock to global services. Ironically, the manufacturing data were surprisingly robust in March, although this trend is likely to turn lower in April. Now that the magnitude of the growth shock is better understood, the next key focus will be how long it lasts. We’re looking to China (theme 3 below) to get a better idea.
Coronavirus impact – theme 3: China’s economic recovery
Given China was the first country impacted by coronavirus, its economic data and virus infection rates will be important markers going forward. China’s high-frequency data suggest that growth did improve in March, but remains well below normal levels – next week’s PMI data will provide a better picture of where things stand (Chart 1). Meanwhile, China’s domestic infection rate is now nearly zero and the Government announced it would lift the quarantine on Hubei Province in early April. That said, imported infections are growing and China announced this week it would restrict entry into the country.
Chart 1: Composite PMI trends: China led, other markets are following
Coronavirus impact – theme 4: Lessons learned from China?
For the rest of the world, the news flow from China should provide some encouragement, at least at the margin. China has shown the virus infection trend can be flattened, but only with draconian measures to shut down the economy. Now China will provide some guidance on how quickly the economy can be turned back on, and how infection rates respond to any relaxation. It is unlikely the West can fully follow China’s model, but at the very least it provides a framework for thinking about it.
Coronavirus impact – theme 5: European infection and mortality rates
Of course none of the learnings will matter until coronavirus infection rates are under control outside of Asia, and here the news story is bleak. Trends across the UK and Europe, especially Spain are worrisome. However, we were pleased to see Italian infection and mortality rates showing tentative signs of stabilisation and we hope this trend continues.
Chart 2: Trends in Italy are stabilising
Coronavirus impact – theme 6: Spotlight on the US
The biggest new narrative in coronavirus crisis is the US, where the number of active cases overtook Italy on Thursday 26 March. In fairness, this number is statistically misleading, as US testing has picked up and population size is much larger. But this doesn’t take away from the fact that both infection and mortality curves in the US are steepening sharply. Given the mixed messages on crisis response between Washington and individual states, the lack of universal health care and weak countercyclical buffers, the coronavirus crisis was always likely to be a unique challenge for the US system. This theme now appears to be gaining some traction. Interestingly, as cross-currency funding conditions normalised through the course of the week, the US dollar came under renewed pressure. It is probably too early to say whether this is a sustainable trend, but we do see downside risks to the US dollar, with coronavirus challenges just one of the driving factors.
Tug-of-war: Good policy, bad growth and mixed infection rate trends
As we can see, through the ebb-and-flow of market moves, the real story of the past few weeks is the increasing tug-of-war between good policy, bad growth and mixed trends in coronavirus infection rates. It will take time for markets to work through them hence it is too early to increase our appetite towards more risky assets such as equities. As ever, we’ll be watching closely so stay tuned for our weekly thematic updates.