Investment News June





Please find the PDF version of this newsletter here

Speed Read

  • With 444.000 deaths worldwide and 8.1 million people infected with the Covid-19 virus, there is a global pandemic.
  • Due to Covid-19, nearly all countries in the world went into a lockdown including large parts of their economies and therefore, the economic consequences are also enormous.
  • The global economic decline in the first half of 2020 appears to be -10%.
  • In almost all countries, the number of new infections has been decreasing very rapidly since late April, early May.
  • As a result, the relaxation of the global lockdown can be accelerated.
  • This will enable a relatively strong economic recovery in the second half of 2020 and 2021.
  • Financial markets are already anticipating on this. For example, the Dow Jones rose 32% since bottoming on March 23. Nevertheless, the MSCI World Index in Euro is still 7.4% below the level at the beginning of this year.
  • Stock markets are not cheap however, may continue to rise if the lockdown reverses relatively quickly and the economic recovery begins soon.
  • The effective yield on high quality government bonds is close to zero or even negative. These bonds therefore only make sense in a portfolio as risk diversification.
  • Corporate bonds offer a more attractive return and benefit from support purchases by the Central Banks.
  • In times of crisis, the US dollar always is a default Safe Haven

Economy

More than 5 months after the Covid-19 virus first appeared in the Chinese city of Wuhan, the dramatic consequences of the virus are becoming increasingly clear. Officially around 8.1 million people worldwide have been infected with the virus and over 440,000 people have died from the virus (based upon mid June statistics). Although the Covid-19 virus has caused a worldwide health problem, The US, with over 120,000 deaths, have been particularly affected.

In addition to the US, Spain also stands out in a negative manner with the highest number (600) of Covid-19 deaths per one million inhabitants. It is also noteworthy that Germany, with “only” 100 victims per one million inhabitants, scores relatively “well” compared to other Western countries.

Due to Covid-19, nearly all countries in the world went into a lockdown including large parts of their economies and therefore, the negative economic consequences are very significant.

For example, the economic decline in the US in the first quarter of 2020 was -1.2% on a quarterly basis, while the economic contraction in the European Union was -3.8%. In countries such as Italy (-4.7%), Spain (-5.2%) and France (-5.8%), the decline rate was even higher because the lockdown in these countries was more stringent and started earlier.

Although the growth figures for the first quarter were dramatic, it should be remembered that the lockdown in the West only started in March and was therefore “only” one month. Figures for the second quarter will therefore be many times worse than those shown regarding the first quarter as this time there is not one, but two months of lockdown.

In addition, June shows only a gradual relaxation of the lockdown. As a rule of thumb, we can take that if on average 35% of the economy is in lockdown, this will result in about a -3% (35% divided by 12 months) economic contraction per month.

Assuming that the lockdown lasted two months this quarter and will be lifted by mid June, the second quarter will result in a contraction of approximately -7.5%, concluding that the global contraction in the first half of 2020 would amount to about -10%. As the first half of the year can therefore be considered lost, it is crucial what will happen in the second half of the year.

Will there be a recovery and if so, will there be a “V-shape” or a “U-shape” recovery? In our opinion, a “V-shape” recovery certainly remains an option, especially now that lockdowns are gradually but steadily being phased out since the number of Covid-19 infections has been decreasing drastically for some time.

In many countries, the peak in infections was reached in late April, early May and we have seen a rapid decline in new cases in all countries since then. It is therefore to be expected that the reduction of the number of lockdowns in various countries will go faster than expected, which means that the (global) economy can also recover faster than expected. The equity markets seem to have already taken this into account.

It is remarkable to see in the graph below that the MSCI World Index not only indicates that shares had been declining for some time before the Economic Surprise Index also started to fall, but that the same now also applies to the recovery in the stock markets. Following the recovery in the stock markets since March 23, the Economic Surprise Index has also started to recover.

Although the economic decline in the first half of the year was mainly caused by a collapse in household consumption, it is certainly positive that the latter is not the result of loss of income, but of increased savings.

The decline in consumption of US households by -6.8% year-on-year was accompanied by an increase in savings of the same households by 10% of disposable income.

Apparently, the economic decline is largely a result of postponement of consumption. Consequently, as soon as the lockdown is lifted and the fear of the Covid-19 virus disappears, there will definitely be an increase in demand.

In addition, the economic decline, estimated at -10% in the first half of the year, has been accompanied by both massive Monetary and Fiscal stimulus from Central Banks and Governments. These policymakers in total have made an estimated $ 18.900 billion available to deal with the adverse effects of the Covid-19 crisis, an amount exceeding 20% of the global economy which leaves a “V-shape” economic recovery in the second half of 2020 and 2021 a valid possibility.

The economic recovery will be moderate in the first instance. As a result of the Covid-19 crisis, stocks at companies have increased considerably and their profit margins are under considerable pressure this year.

 

 

Financial Markets

 

As a result of the huge cost burden for businesses due to the Covid-19 virus and the lockdown, major corrections took place in the financial markets. The Dow Jones fell from a high of 28,538 to a low of 18591 (-35%) in 4 weeks, more or less according to the analysts’ anticipated earning downgrades.

As soon as Central Banks and Governments started with the aforementioned relief measures and made it clear that they are willing to cover a large portion of the costs, financial markets recovered significantly, and the Dow Jones rose by more than 32%. In addition it became clear to the financial markets that in addition to major losers (Aviation, Oil, Financial Services, Hospitality, Transport), there were also a number of companies and sectors that “took advantage” of the current crisis (Supermarkets, Web shops, Healthcare, Biotech , Telecom, IT).

As usual in times of great economic uncertainty, gold, bonds and the US Dollar acted as a Safe Haven and commodities and currencies of developing countries declined significantly.

The biggest losers so far, however, are oil; a result of excess production with a sharp fall in demand, and  the Brazilian Real which declined significantly due to the terrible lack of Covid-19 measures and bad economical policies.

In the foreseeable future, financial markets will mainly be led by signals that indicate how quickly lockdowns will be reversed, whether the Covid-19 virus will strike again later this year, how strong the economic recovery will be and who will pay the bulk of the bill, companies, households or governments and Central Banks. For the time being, the outlook is not unfavorable, and confidence is gradually increasing again, which can be derived, among other things, from an important Leading Indicator such as the European ZEW Index.

 

 

Shares

 

The MSCI World Index in Euro, at the end of May, was still 7.4% below the level at the end of 2019, this despite the strong recovery since March 23, 2020.

Despite this substantial correction however, it cannot be said that shares have become cheap. Although the price drops initially led to a lower price / earnings ratio, it soon became clear that the corporate profits in 2020 were also going to be significantly lower than analysts had expected in early 2020. Despite the lower stock markets, the current price / earnings ratio is even slightly higher than before the Covid-19 crisis erupted.

Crucial to determining whether a strong recovery of corporate earnings is possible in the coming years, which makes shares at current prices still interesting, is the question whether a strong economic recovery is possible in the second half of 2020 and the years thereafter.

The first signs are encouraging in that respect. As in China, in the West the lockdown also appears to be released relatively quickly after more than two months, enabling a relatively strong “V-shape” economic recovery. Moreover, an important part of the economic decline appears to be the result of the fact that although households consumed less during the lockdown, they also saved extra money. Consumptive catch-up demand from households is therefore possible and perhaps even likely. Moreover, although bankruptcies are bound to take place, policy makers such as Governments and Central Banks seem to be keen to compensate companies and households as much as possible and to stimulate economies.

However, it is likely that money will be spent differently by consumers, meaning that successful companies of the past will not automatically be successful in the future. Companies in IT, Healthcare, Telecom, Biotech, New Energy and Web shops, for example, appear to be profiting, while companies in the Aviation, Oil and Financial services sectors, for example, will continue to experience difficulties.

An actively managed portfolio with a clear preference for companies and sectors for the future therefore seems to be a better investment than a passive broad Index Tracker.

 

Government bonds

If we compare 10-year government bonds in America (0.65%) and Germany (-0.45%) with equities, the conclusion can only be that government bonds are not particularly attractive.

Although the Covid-19 crisis will result in companies paying significantly less dividend in 2020 than previously expected, even then it cannot be denied that at current stock prices, both in America (+ 2.0%) and in Germany (+3,0%) the dividend yield, albeit declining, is still considerably higher than the interest rate on government bonds. In fact, US and German government bonds in a portfolio are only suitable as a safe haven and risk diversifier.

 

 

Corporate bonds

As a result of the Covid-19 crisis, corporate bonds have become more attractive compared to government bonds. Spreads of both Investment Grade and High Yield corporate bonds have widened significantly.

Although businesses will go bankrupt in 2020 and spreads have declined again, these spreads still look attractive.

Firstly, Central Banks such as the ECB and the FED support corporate bond markets with large buyback programs.

Secondly, governments and Central Banks have indicated that they will make every effort to help these companies, if necessary and possible, with (re) financing on favorable terms.

Thirdly, households have postponed their consumption expenditure and increased savings and thus certainly not lost their purchasing power.

Fourthly, Central Banks and especially governments have indicated to do as much as possible to compensate companies and households and to enable an economic recovery in the near future.

Therefore, significantly fewer companies will likely go bankrupt than the financial markets still are expecting today.

Currencies

As usual, the US Dollar benefits in particular from its safe-haven status in the event of a crisis and the currencies of developing countries are among the biggest losers.

One of the most structurally undervalued currencies is the Euro. The Eurozone is a region with structurally low inflation. This, in combination with the undervalued Euro, means that the Eurozone has a huge surplus on the trade balance. Against the currencies of its 40 most important trading partners, the Euro is about 8% undervalued, against the Dollar this is even about 20%.

Should the Eurozone ever succeed in acting truly as one, like the United States, a significant appreciation of the Euro is imminent.