The political choices made today will determine the extent of the slowdown and the speed of recovery.
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Investigators face deadly virus forcing companies around the world to shut down, oil prices plummeting for other reasons, and politicians taking extreme measures to cushion the shock to a climate of heightened uncertainty and volatility and to the accentuation of correlations on the financial markets. Faced with this unprecedented global challenge, the consequences of which on markets and the economy are difficult to predict, Invesco’s multi-asset experts have developed several scenarios to determine whether the massive sales that have recently occurred in the markets constitute real purchasing opportunities or are only one stage of a much more serious crisis.
“This is not the year we planned and we do not know how it will end,” said Paul Jackson, global head of asset allocation research at Global Thought Leadership, in the March 2020 issue of The Big Picture, the quarterly publication by Invesco Global Market Strategy Office on the market outlook. Everything seems possible. You can easily panic and run away – literally and in a very defensive portfolio position – but you don’t really know which assets offer suitable diversification today. Liquidity seems to be the only asset that is still uncorrelated from events, but that could change if the banks have difficulties. ” Given the increasing correlation between assets, judgment becomes even more important than usual when trying to diversify assets.
Ideally, global GDP growth
will be 2% in 2020, compared to initial forecasts of 3%.
To form an asset allocation model, Paul Jackson and his team developed four scenarios, from a deep global recession to a simple downturn. In the best of cases, global GDP growth will be 2% in 2020, compared to initial forecasts of 3%. In this case, Invesco experts predict that the S&P 500 will come out at 3,000 in 12 months, gold would reach $ 1,325 an ounce and a barrel of Brent $ 45. According to the worst-case scenario, world GDP would contract by 3.5% in 2020. According to Invesco experts, the financial markets would then behave as in the last global financial crisis in terms of yield curves, spreads, multiples, etc. The S&P 500 would plunge to 1,400 in 12 months, the ounce of gold would be 1,750 dollars and a barrel of Brent 20 dollars.
Invesco’s multi-asset experts have run asset class optimization programs using these four scenarios and using a probability weighted average. While they believe stocks (except the U.S.) will perform well in the optimistic scenarios when CAPE approaches 10 in some regions, they don’t think it will prevent them from further losing value in the months to come in the event of a deep global recession. Their models advocate a dumbbell strategy that overweight defensive assets such as cash and gold, as well as more cyclical assets such as commodities and real estate, which prove attractive over the long term. Gold has dropped a bit and could rise again if the worst-case scenarios materialize, observes Paul Jackson. Raw materials are cheap, especially oil, and in real estate, yields have risen sharply in recent weeks, which suggests attractive earnings in all but the worst case scenarios. ” All scenarios also favor investment-grade credit (IG). Geographically, Invesco experts prefer assets from the United Kingdom, Japan and emerging markets, most of which today have wider spreads than their equivalents in developed markets.
Invesco experts predict that services will be less affected overall than the industry. The US economy therefore appears to be in a better position than most others, especially given its relative independence from trade flows. While some sectors, such as travel and recreation, are currently on hold, others will take advantage of the present circumstances. This is the case with medical device manufacturers, manufacturers of toilet paper or hand sanitizer, food companies and distributors. In the equity market, the following sectors have performed relatively well since the start of the year: distribution, food, beverages and tobacco, personal care, pharmacies and grocery stores. Not surprisingly, health care is performing even better, given the research being done to find a vaccine and the need for public health providers to provide resources to the private sector.
It is no exaggeration to imagine that the deficits
budgets reach 10-20% of GDP this year.
Regarding market reactions, Paul Jackson and his team rely on three elements that could interrupt the current wave of panic. Firstly, the fact that the number of deaths and contaminations by COVID-19 outside of China is reaching its highest point, secondly, the implementation of measures causing a “stupor and terror effect” on the financial markets and intended to protect the cash flow of companies and households, and finally, the development of a vaccine and treatments. As the production of an effective and approved vaccine will take at least 12 months, hopes turn to efforts to end the epidemic and the budgetary and monetary responses to the economic crisis.
These measures, which are reminiscent of those taken during the global financial crisis, are coming in numbers quickly and are constantly increasing. Actions to facilitate loan growth depend, however, on the willingness of banks and their customers to complete these transactions. It is becoming increasingly apparent that States will have to intervene to replace the usual sources of income. “We think these measures will become widespread, but they will come at a cost,” said Paul Jackson. According to him, it is not an exaggeration to imagine that the budget deficits reach 10 to 20% of the GDP this year, a level which one associates rather with a period of war.
If, under “normal” circumstances, economic and business data support analysts’ judgments on the economic cycle, Paul Jackson underlines that the data prior to February 2020 are no longer relevant and those concerning the period during which the economies are in neutral are completely unnecessary. What matters now, he adds, is how quickly economies recover, how quickly activity will return to normal levels, if you can recover lost production and at what level, and if there is irreversible damage, with bankruptcies for example.
The extent of the damage to the Chinese economy in the first quarter of 2020 is not yet known. Declining retail sales and capital investment suggest, however, that China’s GDP fell over this period. According to Invesco’s multi-asset experts, other countries will experience the same situation between the end of the first quarter and the start of the second. They therefore believe that a technical recession (two quarters of negative growth) is possible worldwide, with growth over the year depending on the speed of return to normal and the recovery of lost production. “The political choices made today will determine the extent of the slowdown and the speed of recovery,” said Paul Jackson.
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