February was particularly challenging for global equity markets, which experienced an 8,5% correction over the month due to the coronavirus epidemic, as markets feared the impact on global supply chains, the slowdown in international trade, and the restrictions placed on tourists. A situation like this is likely to deal a blow to business and household confidence.
The OECD expects the epidemic to peak in the first quarter with a “moderate” number of cases outside China, the epicentre of the virus. For example, global growth is expected to fall to 2,4% in 2020, China’s growth is expected to fall to 4,9%, 1,2 percentage points lower than last year, and economies that are highly interconnected with China, such as Japan, South Korea and Australia, are also expected to be affected.
At the height of uncertainty, markets were expecting a rapid response, and the US Federal Reserve (Fed) urgently cut interest rates by 50 basis points with the primary aim of restoring short-term confidence both in the markets and in the real economy. In our opinion, the response should not be just monetary, because fiscal support for the economies is imminent.
Hong Kong set an example by granting an exceptional distribution of the equivalent of EUR 1.200 to every adult citizen to support consumption. In Europe, the Italian government also intends to spend more by applying the clauses of the Stability Pact that allow it to avoid breaching European budgetary rules.
In the financial markets, performance calculated in euros was negative at the end of February: the MSCI World, the international equity market index, lost -7,54%, while its European and US counterparts lost -6,21% and -8,35%, respectively. This context of correction has caused performance calculated in euros over 2020 to fall into negative territory.
In fact, investors fear that the virus will spread in such a way that governments will be forced to impose drastic quarantine measures (for example, the Italian government has quarantined 11 cities in the north of the country), and companies will be forced to shut down their operations (as Apple and Adidas have done in China). Initial comments and earnings of companies show that the proliferation of the coronavirus does not bode well for upcoming earnings reports. For example, according to brewer AB Inbev, Covid-19 is expected to have a negative impact on its first-quarter income of USD 285 million. Similarly, Booking.com, the online hotel booking platform, expects a fall in bookings of -5% to -10% in first quarter of 2020.
Lastly, historically, viruses such as EBOLA and SARS had a short-term impact on the financial markets without any long-term devastating effect on the global economy. That is why we are remaining neutral on the equity markets.
However, we should not jump to conclusions about the end of the current economic cycle and the rise in the financial markets. First of all, central banks throughout the world are continuing to support the economy by applying highly accommodative monetary policies. Secondly, low interest rates are also a positive contributor to equity markets. Lastly, historically, viruses such as EBOLA and SARS had a short-term impact on the financial markets without any long-term devastating effect on the global economy. That is why we are remaining neutral on the equity markets.
From a geographical perspective, we still have a slight preference for the US market over the European market. With that in mind, we are taking advantage of access to secular growth stocks, which are more numerous in the United States than in Europe. Moreover, the safe haven nature of the US dollar provides additional protection in the event of a downturn in the financial markets. It should also be noted that the Fed has more leeway than the European Central Bank (ECB) in stimulating the economy and supporting the financial markets.
In terms of our sector recommendations, we still favour Communication Services, Real Estate, and Healthcare. Overall, these sectors offer better growth profiles, benefit from lower rates and trade at reasonable valuations. They are also less susceptible to the spread of the coronavirus than other sectors.
We have revised our exposure to the Utilities sector to neutral due to a growth profile that is much greater than average (US earnings rose 21,6% versus only +0,9% for S&P 500 stocks). In addition, the sector benefits from a low risk profile due to its regulated activities and domestic exposure.
On the bond markets, inflation expectations are being lowered in the US, and the Fed was quick to surprise the markets by cutting its key rates. The 10-year US Treasury yield is below the critical threshold of 1,00%, while the 10-year German Bund is below -0,60%. With an entirely negative German yield curve, it is currently difficult for us to give a recommendation to buy these securities. We have no particular concerns about private debt. Even though the forecasts of the most cyclical companies have been revised downwards, the asset class continues to be attractive in terms of yield, especially since US sovereign rates have fallen below 1%.
We are maintaining a positive bias for debt issued by defensive—and therefore non-cyclical—companies, that are demonstrating observable financial prudence in managing their balance sheets.
The recent strengthening of the euro is explained by market expectations of rate cuts by the Fed. These expectations were confirmed by the Fed’s 50bp emergency cut on 3 March. As a result, the differential between US and European rates has become relatively more favourable to the euro, which has emerged stronger. In addition, it is difficult to foresee the possibility of aggressive rate cuts within the eurozone, in contrast to the action the Fed is likely to take in the US. Given the volatility levels, we are remaining within the range of 1,08-1,13 reported in previous editions.
We continue to favour exposure to the evolution of the gold price through the shares of mining companies, which can benefit from significant operating leverage. Moreover, it is exactly this situation that their latest earnings reports describe: generated cash flow is on the rise and dividends are increasing. What's more, debt is falling and capital spending seems to be under control. We believe that the price of gold should remain stable above $1600 per ounce, with real upside potential in the event that stock markets remain in a turbulent environment or the number of coronavirus infections escalates dramatically.
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This document was produced by the Private Banking Unit and BCEE Asset Man-agement. The drafting of this document was completed on 05 March 2020 at 11:10 am.
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