Virus, volatility and value
Policymakers’ very fast reaction to the coronavirus crisis prevented a wave of bankruptcies. As long as the lockdown remains temporary and monetary and fiscal support during the lockdown is sufficient to prevent a wave of insolvencies, economic activity will be able to rebound fairly quickly and robustly. However, the pandemic will mark a turning point in our lives and thinking.
What developments or reactions on the securities markets surprised you the most following the outbreak of the coronavirus pandemic?
The most surprising element of this crisis was the speed with which the market selloff evolved. In the case of the S&P 500, for instance, it was the fastest correction on record – not the deepest correction, but the fastest. There was hardly any time to react. It was also surprising to see how quickly policy makers were able to put together stimulus packages. Policymakers were able to react rapidly because the underlying mechanics of the crisis are very well understood. The lockdown measures mean that companies and households lose revenue because shops and factories are closed. However, their costs remain, meaning that they are quite quickly experiencing liquidity stress. Policymakers provided the liquidity quite rapidly, which is a positive sign, and I guess this speed is also a lesson learned from the 2008 financial crisis.
Worldwide gross domestic product growth for 2020 is expected to be clearly negative. What are the most important preconditions for avoiding a prolonged slump?
Our forecast for global GDP growth this year is –3.6%, due mainly to a projected very sharp contraction in Q2, which will drag down average growth for the entire year even if we do get a sizeable rebound in Q3 and Q4. We think that the fiscal and monetary policy measures announced so far are big enough to prevent a very bad economic outcome. As lockdown measures are now eased, we think that growth can snap back relatively quickly. That, of course, hinges on the assumption that the spread of the virus can be contained and a second wave of infections remains manageable. Another assumption is that the stimulus is sufficient to prevent a wave of bankruptcies. If companies can survive the lockdown, then shops and factories can be reopened and economic activity can return to normal. However, if companies go bankrupt during the crisis, then there won’t be a return to normal and we could see a prolonged slump. Growth is shut down for now, but with the right mix of policies, the damage needn’t be permanent.
Once the coronavirus crisis has been overcome, do you think that companies will reorganize their supply chains to make them more crisis-proof, even if the associated costs put a dent in their earnings and stock valuations?
Yes, I think so. Just think about the trade war between China and the USA and the introduction of tariffs we saw last year. The pandemic is now accelerating this process.
Central banks had already been conducting ultra-accommodative monetary policies for many years prior to the coronavirus crisis and are now injecting additional liquidity into the economic system. How might or ought a gradual “return to normal” proceed?
The liquidity injections are a temporary measure and can be ended once economic activity returns to normal. The general interest rate level and the size of central bank balance sheets are a different matter. Here we have seen that even after many years, balance sheets are still as bloated as ever and that, apart from the Fed, other central banks have not been able to raise interest rates. We think there are several factors that make normalization unlikely. The first is demographics – as populations age, nominal growth rates come down and equilibrium interest rates fall as well. The second is indebtedness. As government debt increases, low interest rates are needed to help keep debt servicing costs in check. So, while we do expect emergency measures to stop relatively soon after the acute phase of the crisis is over, we nonetheless think that interest rate levels are likely to stay low for quite some time and that central banks’ balance sheets are unlikely to shrink significantly.
Policymakers provided liquidity quite rapidly, which is a positive sign, and I guess this speed is also a lesson learned from the 2008 financial crisis.
How has the Global CIO Office changed the way it has been procuring and processing information since the outbreak of the coronavirus pandemic?
I feel that our processes have been robust enough to cope with the challenges since the outbreak. The diversification we have in a global setup has allowed us to work with great speed and diligence. This has worked quite well for us during this crisis.
In every crisis there are also winners. Which industries and suppliers rank among those winners?
Some of the big winners during the current coronavirus crisis are digital companies, i.e. those that enable information sharing, videoconferencing, video streaming, etc. Things like online shops are also benefiting. We have also identified what we call “stay-at-home stocks” that should perform well in the current environment. Online gaming companies, for instance, are part of that basket. The general trend toward digitalization is one of the high-conviction, long-term investment themes that we have identified in our Supertrends, which are changing human behavior and how societies work. Other themes addressed include infrastructure, healthcare, climate change and sustainability. We believe that the coronavirus pandemic will mark a turning point in our lives and thinking, and the Supertrends look at some of the changes that could occur going forward.
Isn’t the earnings potential already priced into those stocks?
Those industries, of course, are already trading at a valuation premium relative to the overall market, but we think this premium is justified. After all, this is where we get double-digit growth rates. We think these sectors will continue to show above-average dynamics, so they can continue to outperform, in our view.
How would you rate the outlook for real estate assets in Switzerland and other markets?
We generally have a positive outlook for real estate because it provides a source of yield, which investors will increasingly have to look for given low interest rates. Given the digitalization trend, some areas such as retailing real estate face challenges, but generally we think that real estate is likely to continue producing positive total returns.
Has the time come to increase the asset allocation to commodities in the wake of the oil price shock? What are the key buy signals?
Actually, we are overweight commodities. At this stage, prices are really beaten down, particularly in the oil market. The open price war between OPEC and Russia, which broke out right during the escalation of the coronavirus pandemic, has caused a massive correction on oil markets. Markets were faced with a sharp drop in demand for oil as travel and transportation activity was cut back massively. At the same time, markets are awash in supply because the biggest producers are battling for market share. The agreement between OPEC and Russia to reduce output is a first step in the right direction. In parallel to that, the drop in real interest rates during the crisis is benefiting gold and other precious metals. We think that commodity and oil prices can increase from here.
Investors who are able to avoid negative interest rates are fond of preaching that “cash is king.” How would you respond to them?
Cash may be king during a liquidity crisis, but as a long-term investment strategy, it won’t help investors to achieve their financial objectives. Interest rates for cash are very close to zero or negative in most major currencies.
The correction on the stock markets unfolded in waves. Will a recovery proceed in waves as well?
Yes, I think so. The economic recovery is unlikely be a smooth one because the nature of this shock will lead to unrecognizably bad and often unreliable economic data, and because it has become nearly impossible to predict the path ahead. However, I am confident that the stimulus measures announced so far worldwide will prevent a depression-like economic outcome. After the substantial correction we have started to reenter the markets. We went overweight equities in late March and went overweight credit in April with measured buys/positions. The key lies very much in broad diversification, including geographic and time-horizon diversification.
Let’s end with the sixty-four-thousand-dollar question: will the recovery be V-shaped or U-shaped, or even W-shaped?
One may overemphasize the geometry of the recovery versus the shape of the shock. As long as the lockdown remains temporary and monetary and fiscal support during the lockdown is sufficient to prevent a wave of insolvencies among households and companies, economic activity can rebound quite quickly and significantly.
To give an example, if you need to close your restaurant during the lockdown, the economy will lose this business activity as long as the restaurant is closed. However, once the lockdown eases, you can reopen and hopefully resume activity, hopefully reaching pre-pandemic levels fairly quickly. Some consumption decisions that were postponed during the lockdown will be implemented later this year. This argument supports a V-shaped recovery.
The big uncertainty surrounding this view is time. The depth and duration of slow and low economic growth may leave behind structural damage. The longer the lockdown, the more stimulus the real economy will need to be resuscitated back to something resembling normalcy and eventually recover. However, policymakers seem to understand the urgency of the crisis, so at the moment there is optimism that we will see a rebound in global growth in Q3.