Global Weekly: Loosening lockdowns, increasing equity risk

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The perception of the timing and pace of the restrictive lockdown measures is continuing to dominate equity markets sentiment. New infections emerging in China and South Korea have weighed on the Asian equity markets, as did the increased risk on a re-emerging US/China trade conflict. Although the reopening of Disney theme park Shanghai stirred hope that other parks would re-open sooner than anticipated.

Members of the Fed warned that loosening the lockdown may not revitalize the economy as quickly as expected. Fed Chairman Jay Powell stressed the need for more fiscal aid to limit lasting harm. His words also incited the growing sentiment that the recent equity market rebound does not properly reflect the near-term risks ahead.

In Europe, banks and insurers reacted negatively to quarterly reports, citing increased credit quality doubts. The full impact of the corona crisis may only come to the surface in the quarter ahead.

Financial problems of several airline operators weighed on the performance of travel and leisure stocks. Online travel agency Booking indicated that room/night occupancy declined more than 60% in March and more than 80% in April. Additionally, management indicated a return to pre-corona occupation levels are not likely before 2022.

On the other hand, communication services benefited from stronger-than-expected results from pan-European telecom operator Vodafone. On US markets, consumer staples showed resilience. Changing consumption patterns due to the coronavirus offer opportunities for this defensive sector.

Bonds: Easing measures help recovery

Governments have announced new measures to ease the lockdowns. Markets took this as positive news, switching to a risk-on sentiment. As usual, US and German government bonds saw yields picking up, and eurozone peripherals recovered some of their previous losses, generating positive returns for our tactical allocation.

This picture could change drastically, however, depending on the conflict between the European Central Bank (ECB) and the German court. The latter is against letting the ECB do whatever it takes to support the economy. If it turns out as such, this could generate a sell-off in peripheral sovereign bonds and possibly raise political tensions between members of the union. Nevertheless, we think the ECB mandate is more important than the judges’ ruling under these special circumstances, and that the ECB as an independent institution will carry on propping up these sovereigns and European corporates.

The going-back-to-work initiative from governments around the globe proved particularly beneficial for our risky assets. Global high-yield credits rallied in a matter of a week, and emerging market debt (EMD) recovered investors’ trust. Overall, the biggest loss year-to-date during the pandemic was 15% for sovereign EMD, a bit more for high-yield corporates and, far less, up to -10% for the safest of the three, emerging-market corporates. Currently, the rally diminished the year-to-date loss for emerging-market corporates to -8%, and for sovereigns EMD and high-yield corporates to -11%. Because we had an overweight in EMD, and the highest losses were in high-yield corporates, this was favourable for our active allocation.

The corona situation is uncertain by definition. The recovery could be strong if a vaccine is found, while the fall can be big if the recessionary effects on the economy are worse than expected. We hold on to an overweight towards high-return bonds such as EMD, but we remain vigilant towards the path of the economy. We can decide later to make further changes, either to tilt towards a more defensive or a more risky positioning.