Market comment - More sombre outlook

News item -

As the coronavirus continues to threaten lives across the world, the extent of its effects on the economy is also increasing. ABN AMRO has turned more negative on the consequences of the impact of the virus and the shutdown of economies around the world.

Current headlines about the spread of the coronavirus have replaced normal economic data for many analysts. Macroeconomic data, frequently published with a lag of more than a month, cannot keep up with the news headlines reporting daily infection rates and fatalities. One indicator with little lag, the weekly report of US jobless claims, has rocked markets two weeks in a row. Almost ten million newly unemployed Americans have filed for unemployment compensation in the last two weeks.

The surge in joblessness is owing to the lockdown of almost the entire US population and the closing of all but essential businesses. Just as in Europe, schools and businesses are closed for about 95% of the US population. Lockdowns in both regions have the possibility of being renewed, which illustrates just one facet of the uncertainty confronting consumers, employers, and businesses large and small. The fact that the underlying reason for this standstill is a new and deadly worldwide virus, adds a foreboding element to any forecast.

What ABN AMRO expects

At ABN AMRO, we have been working with different scenarios that enable us to compare the developing situation with our expectations. This, in turn, provides the basis for investment decision making. Our initial scenarios, developed in February, are now being adjusted and our base case scenario has become more grim.

We now expect a bigger hit to economic growth, with US GDP declining by -4.8% in 2020, rising to +3.4% in 2021. In Europe, economic growth is expected to decline by -4.3% this year and rise to +1.6% growth next year.

One reason for the increased pessimism is that we now assume that the lockdown periods will be longer. For the eurozone, this means a lockdown until the end of April and for the US until mid-May. We also expect a larger hit to the US economy, as the lockdown that is now imposed covers just about the entire economy. There is therefore more spillover into business activities, including corporate retrenchment, in the form of reduced capital expenditures and increased unemployment.

We believe that this will result in an even weaker second quarter than had been expected, although a rebound in the third quarter is still pencilled in for both the eurozone and the US. Negative growth, however, is expected to reappear in the eurozone in the last quarter of 2020 and the first quarter of 2021.

In this environment, central banks are expected to continue to do whatever it takes to absorb new bond issuances, while keeping rates low and markets functioning. Discretionary fiscal stimulus, now standing at around 6% of GDP in the US and 2.5% in eurozone, will likely be increased. Asset purchases by central banks are also expected to grow.

Market uncertainty to continue

Equity markets are expected to remain volatile for at least the next four weeks. This period coincides with the expected peak in coronavirus infection rates in the US, according to the model being used by advisors to the Trump administration. It is hoped that peaks are already being seen in some European countries, such as Italy and Spain --- where there were enough encouraging signs for markets to rally this week. Such volatility is expected to continue until there are firm signs that the virus is truly being contained, the number of infections declines and proposals for exiting lockdowns begin to be seen. Even though markets have reacted positively on the apparent stabilisation of the virus in a number of countries, this does not mean that all concerns are behind us. It is not uncommon for bear markets to show a ‘W’ shaped pattern if sentiment turns again. Wariness therefore continues to be called for.

Bond markets are absorbing the impact of the different stimulus measures currently taken by central banks and by governments. These measures are needed to provide sufficient liquidity and to support the economy, but will lead to higher deficits. The question of how this should be financed leads to difficult discussions between the different European countries. We continue to advise patience with investment portfolios. Some positive signs in terms of infection rates are beginning to be seen in both the US and Europe, but economies remain at a standstill. Markets are volatile and we do not believe it is the time to make any large scale change in asset allocations.

Richard de Groot, Chair, ABN AMRO Investment Committee

For more information on the base case scenario, read “Watch out for the double dip,’’ published in the Global Daily, 4 April 2020, by ABN AMRO Group Economics.