The global economy is slowly starting up again after an abrupt standstill. However, the pandemic results in varying levels of shutdowns across developed and emerging markets. The lockdown measures have caused a sharp deceleration of economic activities in the manufacturing and services sectors, countered with an unprecedented magnitude of monetary easing, financial stimulus and multilateral support. Incoming data and real-time indicators for economic activity are showing cautious signs of a bottoming-out, along with the gradual easing of the containment measures. The pickup in economic momentum has so far been tepid compared with the pace at which the indicators plummeted in the previous months.
Figure 1: Our asset class overweights/underweights in our model portfolio as of July 1, 2020 on a 3-month horizon. Each percentage reflects the relative weighting of the different asset classes within our model portfolio.
In the US, the measures have brought many segments of the economy to a complete halt. Given the massive scope of the contraction, the fiscal and monetary authorities have stepped in on a large scale. The US government has announced over $2 trillion in fiscal aid to affected industries and workers. At the same time, the Fed eased monetary policy and functions as the liquidity provider of last resort by implementing programs targeting various lending markets. These programs can help address the symptoms of the problem by maintaining affordable lending rates and liquidity until the restrictions are lifted. They cannot, however, solve the problem itself. As the lockdowns are being eased, it is likely that economic activity will gradually pick up and labor market dynamics will improve, provided the current resurgence in cases in several states is a temporary phenomenon. As the end of July - and the scheduled end of some CARES Act benefits - approaches, discussions about additional consumer support during a seemingly stubborn pandemic in the US will likely arise.
In Europe, economic activity is picking up as restrictions are eased. Still, it will take a considerable time before economies will regain full traction, and even longer for the economy to reach pre-crisis levels. National governments and the ECB have implemented large-scale support programs that should provide support and liquidity to citizens, governments, banks, companies and financial markets.
The situation is similar in Japan and in the UK, with major economic slowdowns and fiscal- and monetary support packages.
In the near term, the severity of the Covid-19 health crisis, countered with "whatever it takes" monetary and fiscal stimulus in developed economies and additional support from the IMF and China's V-shaped economic recovery, will determine the growth outlook of emerging markets. While China seems to have contained the coronavirus infection, the recent rise in Covid-19 infections in the US and in emerging markets could force the resumption of widespread lockdowns and restrictions. This would place the prospects of economic recovery in jeopardy, resulting in a W-shaped double dip recession. China's manufacturing PMI rose to 50.9 in June from 50.6 in May due to improving production and new orders, including a sharp jump in the export order component. Energy producers in emerging markets will continue to benefit from a faster demand recovery, supported by the production cuts within the OPEC+ alliance.
The outlook for the global economy is strongly linked to the scope of virus-containing measures. If lockdowns can continue to be eased relatively quickly, economic activity can pick up again, supported by the extensive stimulus measures. If economies cannot regain traction, second-order adverse effects will be more pronounced and the potential for a strong recovery diminishes.
On a tactical horizon, we have an underweight position in fixed income and an overweight in alternatives. We are neutral on equities.
Within fixed income: Within sovereign bonds, we are underweight developed world government bonds as yields in the asset class have been compressed, making valuations not supportive. On the other side of that position we are overweight in investment grade and high yield bonds where we see an attractive return-to-risk balance. We have a small overweight in emerging market bonds as technicals are supportive for the asset class. We open an overweight in securitized.
Within equities: We have an overweight in US equities versus underweights in emerging market equities and listed real estate. We are neutral in other regions.
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