The damaging economic effects of the lockdown persist. There is no sign of recovery in either supply or demand, nor any expectation that confidence indicators will bounce back any time soon.
The scope of stimulus programmes is being constantly expanded to offset the economic slump. In the United States, the Paycheck Protection Program, a programme of loans for small businesses with fewer than 500 employees, has been increased from USD 350 billion to an estimated USD 670 billion.
This week, it was the oil market that demanded investors’ full attention.
Every crisis has its own unique features: in 2008, it was negative nominal interest rates; this time, for Covid-19, it's negative oil prices.
From a macroeconomic perspective, a negative oil price demonstrates the weakness of demand for black gold, implying sluggish economic activity.
On the New York futures market, WTI (West Texas Intermediate) crude for May delivery – which expired at the end of trading Tuesday – closed at USD 37 per barrel. This situation meant that the market players responsible for selling or storing the physical barrels found themselves caught in the crossfire, as storage capacity in the United States is completely saturated.
From a macroeconomic perspective, a negative oil price demonstrates the weakness of demand for black gold, implying sluggish economic activity. It also reflects the glut in inventory, with output having far outstripped demand over the last few months. For example, the US Energy Information Administration (EIA) announced an inventory increase of 19,2 million barrels of crude, the largest weekly increase since these statistics began to be published.
Lastly, our efforts to monitor the scientific progress made in the fight against the virus are ongoing. There are currently 150 projects around the world to develop a vaccine. Needless to say, should the attempts be successful, economic players’ confidence would pick up very rapidly.
For the time being, equity markets appear to be consolidating their positions. Governments everywhere are being responsive and new support plans keep on coming, helping to keep economies afloat. Recent announcements by government authorities include the Japanese government’s JPY 117.000 billion boost to its economic support plan to cover funding for all Japanese citizens, not just vulnerable households. In the United States, too, the government is about to release another USD 500 billion, including USD 320 billion to be allocated to small and medium-sized companies.
These measures certainly have an impact on financial-market psychology, as seen in the movement of the VIX – one of the indicators that measures the volatility of the S&P 500 – which slackened off to around 40. However, they cannot make up for the detrimental impact of lockdown on the global economy. Increasing numbers of indicators are showing a material deterioration as they begin to reflect the initial impact of the lockdown. Retail sales in the US are a good example of this: in March alone, they fell nearly 9%. Furthermore, the updates to economic forecasts are chilling.
The Bank of Spain now expects the country’s GDP for 2020 to shrink by between 6,8% and 12,4%, while Rome is forecasting a contraction of 8%. The outlook is no cheerier for businesses. That said, businesses are avoiding concrete figures, with most of them refraining from publishing their forecasts owing to lack of visibility and, most likely, catastrophic data.
The collapse in global demand has probably exacerbated the nosedive in the price of black gold. This situation could shake up prices on the stock exchanges, mainly because the oil sector employs a considerable proportion of the workforce in the USA. However, there is also a risk that the weakest operators may fail, which could stress the foundations of the credit and financial systems.
In this wholly uncertain environment and caught in the stranglehold of the virus’ spread, we continue to take a cautious approach, favouring the healthcare, real estate and communication services sectors and gold companies. In addition, we will also keep marginally and opportunistically taking advantage of attractive valuations on quality companies to build long-term positions. Some stocks have plummeted (losing 40-50% since their peak) and are now trading at reasonable levels. By contrast, we feel that the “growth” segment, encompassing internet stocks and securities from the payment, luxury and leisure sectors, is still too expensive to warrant building substantial positions.
Italian debt has been the focus of all investors’ concerns over the past week, while the country is formulating a lockdown exit plan to take effect from 4 May. The 10-year rate has exceeded 2% and the 30-year bond has already reached 3%. According to the latest figures from Eurostat, which date from the end of 2018, the debt-to-GDP ratio is close to 135%, reflecting the fact that the country was already heavily indebted before the pandemic exploded. The most recent estimates from Italy now forecast a ratio of 150-155% and a budget deficit of 10%, way beyond the Maastricht criteria. Investors’ nerves will be tried again this Friday after the markets close, when Standard & Poor’s (S&P) issues its opinion on BBB-rated Italian debt.
The outlook for debt has been negative since 26 October 2018, which may give the agency the option of revising the country’s rating downwards if it thinks the environment has deteriorated further. In reality, investors are particularly concerned that the debt may be downgraded from investment grade to speculative. In this eventuality, Italian government bonds would be at risk of disappearing from the European Central Bank’s (ECB) asset purchase programme. That won’t happen overnight, though! As long as one of the four rating agencies, be it S&P, Moody’s, Fitch or DBRS, maintains an investment grade rating equivalent to BBB-, the ECB will continue to purchase Italian debt. Even if all four agencies were to issue a speculative category rating, Italian sovereign bonds would still be included in the latest asset purchase programme, worth EUR 750 billion and better known as the Pandemic Emergency Purchase Programme (PEPP), which includes Greek bonds with an average BB- rating. Furthermore, the ECB has relaxed some of its rules for collateral on loans to banks. Henceforth, it will only require a minimum BB rating for securities used as collateral when banks are borrowing money from the ECB, and this should also support Italian debt in the event that it is downgraded.
As bleak as the situation is, the figures for the latest auction demonstrate that there is more of an appetite than ever for Italian government bonds. By paying EUR 10 billion on a bond with a 5-year maturity and EUR 6 billion for a 30-year bond, investors came forward with a cumulative total of EUR 110 billion, shattering February’s record of EUR 50 billion.
Clearly, the Italian economy will not escape recession this year, probably in common with a host of European Union member countries, given that circumstances are extraordinary for everyone.
There will inevitably be capital outflows, and these are estimated at EUR 200 billion should Italy be rated as speculative on Friday. However, appetite will not waver. In fact, many investors, insurers and pension funds, which have particularly stringent yield requirements, can hardly afford to ignore the gains and liquidity offered by the Italian euro yield curve. Nor should it be forgotten that Italy is one of the founding members of the European Union. Its economy is the third largest in the monetary union in terms of GDP, and default by Italy would probably spell the end for this union—a risk that no one wants to take.
The corporate debt segment was relatively calm this week. The uncertainty associated with the lockdown and how long it might last came roaring back: while the oil market provided a major illustration thereof , it also infected the credit market. Risk premiums on European corporate debt widened by just 5 basis interest points at the end of last week, as they did in the US, although we saw a decorrelation of risk premiums in different sectors.
As a result, in line with our convictions, debt from companies with a strong balance sheet in sectors that are seeing little impact from coronavirus posted performances far superior to those with more cyclical debt. For the most part, the former group saw their risk premiums narrow, particularly in the healthcare and utilities sectors. We believe these companies are worthy of our interest at current levels, however, and our preference is to pull back from more risky debt, particularly due to the current flood of ratings downgrades.
Our investments reflect recent developments in the all-pervasive health crisis and the extraordinary responses from governments, central banks and capital markets. Our positioning means we have no need to make urgent adjustments and past decisions are being reflected in performances today. As at 21 April, our Activmandate Équilibré model portfolio posted a year-to-date performance of -6,3%, while the major European indices – the EURO STOXX 50 and the STOXX Europe 600 – closed with performances of -25,5% and -22,0%, respectively, over the same period.
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