Unprecedented Changes Shaping a New Global Landscape

By Alexander Roose,
CIO Fundamental Equity at DPAM


Since the lows reached on March 23, equity markets have rebounded by around 25%, driven by pension fund rebalancing and a decelerating growth rate in infection rates in first-hit EU countries. Also, credit markets got back on their feet to such an extent that corporations are refinancing existing debt at a rapid pace on the US corporate bond markets. Regarding the latter, one of the key triggers was the Fed’s announcement that it will deploy capital from several Special Purpose Vehicles (SPVs), seeded by the Treasury. SPVs will be used to buy investment grade corporate bonds and high yield bond ETFs. Importantly, IG corporate bonds that were downgraded after March 22 (“fallen angels”) will also be eligible for purchase. As already emphasized in past updates, direct purchasing of corporate bonds by the Fed is crucial to make sure that the liquidity crisis does not lead to a full-blown solvency crisis.

Moreover, the Fed has now followed the path of the Bank of Japan in terms blurring the lines between monetary and fiscal policy by directly financing part of the USD 2 trillion Coronavirus Aid, Relief and Economic Security (CARES) Act package, releasing more than USD 450 billion of equity capital from the Exchange Stabilization Fund. The CARES Act mainly targets middle-income individuals/families (30% of the package and mainly through direct payments) as well as large (25%) and small (19%) corporations. There is even talk in the US about an additional economic package totalling USD 1 trillion targeting infrastructure investments. In Europe, the fiscal measures taken at the national level have been impressive in magnitude (as % of GDP), although they vary widely among EU countries, and as in the US, they greatly exceed the efforts made during and after the Great Financial crisis (GFC). The Achilles heel of the European project remains the lack of fiscal solidarity and although the EUR 540 billion support package approved by the Eurogroup’s Finance Ministers is a step in the right direction, more needs to be done in terms of alleviating the heavy burden countries like Italy or Spain will have to carry over the coming years. The cheap credit lines offered through the European Stability Mechanism (accounting for EUR 240 billion of the package) still come with a stigma and Italy has refused to tap them for now. The EU Finance Ministers will discuss again the mechanism of the package on April 23 and start negotiating on a so-called “EU Recovery Fund”, with the issuance of mutualized debt remaining the biggest obstacle. The sense of urgency is high and all EU Members should realize that the burden of the Covid-19 crisis should be shared by all and they should act accordingly. This is a defining moment for the European project.

On top of these “whatever it takes” measures implemented globally, social distancing action plans have been increasingly rolled out and there are encouraging signs that the epidemic is getting under control in some countries. In the US, the epidemic has been slightly less severe than feared and this has been an important catalyst for recent market strength. Does this mean that we are dropping our previous recommendation, “too late to sell equities” in favour of “time to buy equities”? No, not quite, as we reckon that markets have discounted a fair bit of positive developments already. We are not yet out of the woods and this, for the following reasons:

    • Even if markets are starting to turn their attention to lockdown exit strategies (with the greatest focus on the gradual re-opening of the US economy), we expect these to be very gradual and measured, as epidemiologists will warn against the risk of a second wave of the disease in the fall or the risk of re-importing the disease (if travel restrictions are lifted). Singapore, for instance, has been put in a near lockdown after a new wave of infections from migrant workers suddenly surfaced.

    • The economic havoc is unprecedented and with the start of the first-quarter reporting season, more clarity on the real (nasty) impact of this crisis on corporate profits and losses and balance sheets could cause market participants to adopt a more cautious stance.

    • Consumer confidence will be severely impacted due to the combined effect of the health scare and lower purchasing power, the latter caused by the severe recession in the labor intensive services sector. Hence, we do not expect consumers to open their purse ‘en masse’ once the lockdowns are lifted.

    • There are still areas of noticeable stress such as the high yield bond market or emerging market currencies. While an agreement among OPEC+ Members and the US on oil supply cuts has been reached, oil prices remain depressed, as the decline in oil demand is much greater than supply reductions.

In sum, we do not expect a V-shaped recovery (but possibly a U-shaped recovery) . We do not subscribe to the views of some strategists who are making parallels with the GFC. As stated in previous notes, this crisis is not systemic in nature (no “atomic bombs” like CDOs/Collaterized Debt Obligations), banks are better capitalized and relevant authorities have been more on the ball with their monetary and fiscal policies. In terms of valuations, price/earnings multiples at the trough of the market (and hopefully, this is behind us) should be higher compared to 2008/09 on account of the meaningful difference in real bonds yields.

To state the obvious, the Covid-19 crisis has been the catalyst behind the introduction of radical fiscal measures that lean towards left-wing policy in the Western world. And more of these may be under the way. These unconventional fiscal measures could help coping with growing inequality, a phenomenon that was partly reinforced by inflation of asset prices after the GFC, when quantitative easing became a permanent monetary tool. As we speak, share buybacks and dividend payments are getting increasingly postponed, as societal pressure is building to re-direct more of corporate cash flows away from shareholders. And it will probably not stop there. Tax fairness and fair pay for a larger pool of workers are policy themes that will garner broader support. On the one hand, governments will plug the fiscal hole left by the impact of the Covid-19 crisis by raising corporate taxes. On the other hand, they will also increase healthcare-related spending in order to cope better with future medical emergencies. As such, the role of government authorities will increase and this dynamic needs to be taken into account when selecting and investing in companies, both on fundamental and sustainability grounds, for the longer term. There lies an opportunity for DPAM as an active, sustainable and research-driven asset manager.


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