Global Weekly: Looking at the silver linings

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Equity markets embraced the hope that restrictive measures are to be softened as soon as new daily corona infections tend to decrease in several countries. Together with the extraordinary monetary and fiscal stimulus and some relief over corporate earnings, this hope increased investor risk appetite. The partial start-up of the Volkswagen factory in Wolfsburg, Germany, and the announcement of state aid for bleeding airline company Air France-KLM showed the willingness to restore economic activity.

Economic data did not interrupt the recovery of equity markets, as most figures did come as a surprise. US durable goods orders in March showed the biggest plunge since 2014, but excluding aircraft and military hardware, they even rose slightly. Effects of spending cuts will be more visible in upcoming months. US April consumer confidence dropped to 76.4, the lowest level since 2014.

The oil price dropped further, but energy stocks initially recovered, mainly in the US. The announced historic dividend cut by Royal Dutch Shell, however, was clearly a shock to the market and underlines that we are living in extraordinary times. The financial sector, one of the worst performers year-to-date in Europe, also attracted investor attention as not all corporate results were not as bad as feared.

Technology related stocks again showed strength. Alphabet, parent of search engine Google, and Microsoft were both off to a strong start of the year, with no -or in some cases even a positive- impact on sales due to the coronavirus. In fact, these results underpin the relatively strong relative and absolute performance of technology stocks during the sharp market correction we have experienced in the past months.

Bonds: risks and opportunities

In the rear-view mirror, the most recent events look quite messy and do not bode well for global economies. However, the facts are all known and should be priced in, ideally. Investors keep struggling, though, to spot the right value for both risk-free and risky assets in current circumstances, as hard data are lagging.

Additionally, many estimates on the depth of the crisis are based on conditions extrapolated from past experience, although the current mix of events is unprecedented. Not to forget, the next US presidential election is looming in nearly six months. Instinctively, this speaks for lower rates - particularly on core government bonds - which will remain supported by global central banks’ actions.

As a consequence of the low-for-longer environment, risky assets should generally benefit and provide attractive opportunities across various sub asset classes, with a few risky assets even offering equity-like returns. Besides the expansion of central bank balance sheets worldwide, fiscal support will remain strong as to avoid depression-like conditions in the economy. Therefore, we stick to our overweight position both in corporate bonds and emerging markets debt (EMD).

Corporate bonds should experience further support by the most recent announcement from the EU Commission, to provide a series of measures in order to relief bank credit spreads. This is not because the sector is in severe trouble - as in the great financial crisis around 2008- , but to serve as a partial solution for the current situation. It would remove further headwinds for credit growth.

Opportunities in EMD are not yet reflected in bond valuations, but the International Monetary Fund (IMF) has pointed out that emerging-market countries are expected to perform far better than advanced economies. Not just in 2020, but also beyond, given the transitory character of the coronavirus. Once the panic around the coronavirus fades away, the depth of the recession in the US should pave the way for a lower US dollar– which is beneficial for emerging markets.

Italian government bonds could escape from a most recent downgrade of its BBB rating by S&P, but not from Fitch. Fitch surprised market participants by downgrading the Italian credit rating by one notch to BBB-. As such, the relief rally at the beginning of the week faded away quickly. Italian spreads remain elevated, despite the low odds of another downgrade on 8 May by Moody’s. So far, Moody’s is keeping Italy’s credit rating just one notch above junk level.

Currently, it seems unlikely that Italian spreads would tighten substantially to around 170 basis points in the near-term, which marks its 200-days moving average. After all, the risk of a downgrade has not gone away, but it is just postponed towards the second half of this year. Political risks in Italy (as well as in Spain) are rising and are raising concerns for new elections, given the fragility of both governments. We remain vigilant on peripheral spreads.