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A spike of uncertainty


MONTHLY INVESTMENT BRIEF

MARCH 2020

 

Laurent Denize

Laurent Denize,
GLOBAL CO-CIO &
GLOBAL HEAD OF FIXED INCOME


Be patient: an exogenous shock like this cannot be reabsorbed within a few days

The global economic outlook has darkened considerably in recent weeks. Although the spread of the coronavirus seems to be slowing in China, business activity there has dropped even more than expected (with the PMI manufacturing index at 35.7). What’s more, the virus is now spreading quickly outside of China, particularly in certain parts of Asia and Europe and particularly severely in northern Italy. The US are not spared. Economic indicators had been showing some signs of recovery, but it was hard to get an exact reading on the situation, given the uncertain state of trade relations and a weakened manufacturing sector. Against this backdrop, supply chain disruptions will inevitably undermine growth prospects.

So, what could happen?

First of all, given the uncertain contours of this shock to the economy, there is no point in venturing any precise forecasts on its macroeconomic or market impact. The path that the public health emergency will take and the political response to it are two parameters that could alter the trajectories of risky assets. By injecting liquidity, central banks will have a major role to play in preventing bankruptcies, particularly among smaller companies.
Even if lowering rates or injecting liquidity (as the FED has just done) helps to limit the deterioration of financial conditions and restore confidence, this does not solve the supply problem we are facing. Governments have limited room for manoeuvre due to their debt levels and are unlikely to be able to compen-sate with strong stimulus policies. Thus, in our scenarios we must now consider a contraction in world real GDP in the first quarter. The prolongation of the combined supply and de-mand shock could cause the world economy to possibly stall for the year.

That indicators should we keep an eye on in the next few months?

- Credit spreads (an indicator of rising default rates)

- Company sales and profit warnings

- Macroeconomic figures 

- Consumer confidence

- Announcements of central bank and government policies

One more thing: here’s a small indication that the markets have certainly not bottomed out. Prior to the correction, the US equity market was trading at 19 times forward earnings (based on a +9% forecast for 2020). It is now trading at 16.50 or 17. And what will happen if earnings growth is revised down to zero? That would put us right back at 18 or 19. With this in mind, we could see a repeat of last week’s losses before returning to entry points that better reflect this risk.
This may indeed be what we are now seeing – a broad repricing of risk with higher volatility and, as a corollary, future investment opportunities. In the meantime, we reiterate the cautious message that we issued last month. Be patient: an exogenous shock like this cannot be reabsorbed within a few days. That being said, rising temperatures should ultimately rein in the health risk, along with the virus’s global mortality rate. Let’s hope so.

In the longer term, the question of relocating and centralizing value chains must be already be addressed. For what costs and benefits in the medium and long term? Just-in-time pro-cesses have also raised the issue of precautionary inventories and the impact on supply in the event of inventory shortages.

How will companies react in adjusting to this new environment? We got some initial hints during the trade war and this will lead to decisive choices in portfolios and no doubt new value creators will emerge. It is up to us to capture this new trend...

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