Friday, 30th of October 2020
“I think if this country gets any kinder or gentler, it’s literally going to cease to exist.”
– Donald Trump
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Equity markets sold off sharply this week as the coronavirus continued to spread rapidly in Europe, the US, and much of Asia. Draconian restrictions last seen before the summer also made a comeback, with France the latest European country to impose a nationwide lockdown amid spiralling cases. While the MSCI EM Index held up well over the week, the S&P 500 and the Euro STOXX 600 were down -4.5% and -5.7% respectively ahead of the Friday market open. These losses may be the start of a longer, deeper correction for equities – certainly a massive sell-off would be consistent with the dire economic circumstances in which we find ourselves. However, making such predictions when there are so many uncertainties and binary risks to the outlook (from Brexit to the US Presidential election) would be a fool’s errand. We remain cautiously positioned.
What does seem clear is that there is now no hope that countries can avoid a second wave this winter by perfecting a comprehensive system of contact tracing and mass testing. It is too late. The only question today is whether we will see more deaths over the next six months than we did over the last, and how the authorities in each country will respond to the daily barrage of headlines and deteriorating statistics. To be sure, we now know much more about the disease – and how to treat it – than we did back in March. And, using this knowledge, we have been able to greatly reduce the proportion of covid-19 patients who end up in the ICU, or worse. This takes some of the pressure off healthcare systems that might otherwise burst at the seams; and, in time, as new and improved therapies become available, may convince politicians that the consequences of lockdowns are worse than living with the disease. Clearly, if and when an effective vaccine has been approved, it will be a gamechanger. And there are promising candidates being trialled in the US and UK. But we are not there yet. Moreover, as countries in the Northern Hemisphere batten down the hatches ahead of the winter chill and restriction-weary populations retreat indoors, it will be increasingly hard to maintain (and monitor) social distancing. More stringent rules may be the only way to get sufficient compliance to suppress the infection curve to any meaningful degree (even if a light-touch policy would work if most people followed the rules carefully). We therefore expect the next few months to be very hard indeed, and for the economic recovery that much of the world has seen through the summer to stall. For Europe, the preliminary October PMIs show that recession is almost certain to return before year-end, while for the US, which just printed a record Q3 GDP growth rate of +33.1% annualised, the winning streak cannot last forever. Big Tech firms may have released expectations-beating quarterly results this week (confirming suspicions that the pandemic has not slowed the pace of disruption), but the US economy is not equivalent to the market cap of the FAANG stocks.
The grave outlook is one reason we remain pessimistic about traditional fixed income. US and European investment grade (IG) credit spreads have narrowed c.90% since the trough in March. Bonds issued by IG US corporates are now just 30bps wider than they were at the start of the year! At these levels you would be forgiven for believing that the pandemic must be over. But the opposite is true in many ways. As governments tighten up the restrictions on households and firms, they do so in the knowledge that offsetting the economic harm will be harder this time round. There are fewer resources to hand – both monetary and fiscal – and balance sheets have already been eviscerated. Would you lend to a company today that has already leveraged its capital structure aggressively and burnt through all its cash and credit lines just to keep afloat through the first wave of covid-19? Will the government? Should they? At the moment, the Fed and the ECB are hoping that their asset purchase programmes will keep a lid on things. And we expect more support in the coming months (as signalled by the ECB this week). But the current crisis is unmanageable to a very large degree, and the longer it goes on the more downside will materialise. We prefer to look outside traditional fixed income to make our money.
The biggest event of the year is finally upon us. Next week – on Tuesday to be precise – Americans (or at least those of them who have not voted early in record numbers) will head to polling stations up and down the country to select the next President. National opinion polls all point to a big win for Joe Biden and the Democrats, with voters giving the Donald low ratings for his handling of the virus in particular. However, the electoral college means that the outcome will be determined by just a handful of districts and groups, and a Trump victory is by no means off the cards. If Biden is elected, he plans to reverse many of the Trump tax cuts and boost fiscal spending (particularly on ‘green’ initiatives). The former will not impress Wall Street, and US equities are therefore likely to correct in such a scenario. However, in this era of big government the increase in the deficit is unlikely to ruffle the bond market. Probably, the worst-case scenario for markets would be a narrow Biden win that Trump contests aggressively and a Democratic sweep of the House and Senate. We will soon find out either way.
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