Cautious signs global economy is bottoming out

4 minute read

The global economy is still gripped by the coronavirus crisis and a continued major economic contraction. The pandemic has resulted in varying levels of shutdowns across developed- and emerging markets. This has caused a sharp deceleration of economic activities in the manufacturing and services sectors, countered by 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 bottoming out alongside 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 June 1, 2020 on a 3-month horizon. Each percentage reflects the relative weighting of the different asset classes within our model portfolio.

Macroeconomic backdrop

In the US, the measures have caused a complete stop of many segments of the economy. Given the massive scope of the contraction, the fiscal and monetary authorities have stepped in with unprecedented measures. 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, however, they cannot solve the problem itself. Instead, these programs can help to maintain affordable lending rates and liquidity until the restrictions are lifted. As the lockdowns are eased, it is likely that economic activity will gradually pick up and labor market dynamics will improve.

The European situation is similar to the US. Many countries have been in lockdown since March and economic activity has slowed significantly. Leading indicators pointed towards a major contraction with poorer readings than during the heights of the global financial crisis. 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 shutdowns had an immediate effect on the labor markets around the world. In Europe, more than 40 million workers have been furloughed during the shutdowns.

The situation in Japan and the UK is similar, with major economic slowdowns and fiscal and monetary support packages announced.

The emerging market economic outlook is expected to improve, driven by the extraordinary fiscal and monetary policy support and the gradual easing of Covid-19 pandemic restrictions. The fundamental backdrop is improving, despite the pickup in in Covid-19 infection rates in a few major emerging market countries (such as Brazil and India). The expectation is that as lockdowns are gradually eased in emerging markets, the recovery in economic activity will be similar to developed markets. The uncertainty about oil prices has dissipated after the recent rally, as expectations are that production cuts agreed among OPEC+ members will be extended and downward pressure on oil prices will be avoided. Emerging markets remain cyclically linked to global growth from an external demand point, especially from China and developed markets. Absent a second wave of Covid-19, a key risk is that the fiscal and monetary support in developed markets could lose support just as the emerging market growth recovery is beginning.

The outlook for the global economy is strongly linked to the duration of lockdowns. In case lockdowns can be eased relatively quickly, economic activity can pick up again, supported by the large stimulus measures. If economies cannot restart soon, second-order adverse effects will be more pronounced and the potential for a strong recovery diminishes.

Asset Allocation

On a tactical horizon, we have a neutral position in equities versus fixed income and alternatives.

Within fixed income: Within sovereign bonds, we are underweight developed world government bonds as yields in the asset class have been compressed and valuations not supportive as a result. On the other side of that position we are overweight in investment grade and high yield bonds where we see very good return-to-risk trade-off. We added a small overweight to emerging markets bonds as price technicals and the general backdrop are supportive for the asset class. We are neutral in securitized.

Within equities: Within equities we have muted positioning in most markets, with the exception of the Japanese one, where we are underweight. On a relative basis, Japanese equities have negative valuation and price technicals.


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