Welcome back, and what a difference a quarter made. Things were actually moving along fairly well until about halfway through the quarter as the Coronavirus, officially called COVID-19, continued to spread globally. Economic shutdowns led to a broad and very fast market decline. Risk assets sold off across the board. Even higher-quality segments suffered from a liquidity crunch, and only sovereign bonds had positive returns. COVID-19 was the catalyst for the sell-off, and a key signal we’ll be watching is the curve that tracks the cumulative number of virus cases. Progress on the public health front must come first, and if the curve falls below a daily increase of 33 percent, that would be evidence that it’s flattening.
China is an early example. Its curve is flattening, and we’ve seen better news from Europe on this metric too. We’re certainly hoping the number of new cases continues to drop. We’ve seen so far when curves start to flatten, market returns have improved. Before China’s very strict containment measures were put in place, the S&P 500 index outperformed the Shanghai Composite Index. Once the lockdowns were implemented, the performance pattern then reversed. We look at the battle against the coronavirus and its impact on the economy and markets as taking place on three fronts:
First, efforts to flatten the curve of the virus itself. Social distancing has been one of the more notable instances. Second, is providing backstops to those impacted by quarantine measures. Aid to small businesses, for example. And third, implementing programs to allow the orderly funding of credit, such as unlimited quantitative easing.
So, where does the economy go from here? Many market and economy watchers compare the path of economic downturns and recoveries to the shape of the letters of the alphabet. We know the first leg down is pretty sharp and fast. In a V-shaped recovery, the economy would sharply recover after the virus abates. A U pattern would describe a slower, more gradual recovery. While a W-shaped recovery would indicate a series of false starts before the eventual recovery, especially if confidence were to relapse.
Given the uncertain environment and the damage wrought by the virus, our global economic forecasts have been revised lower across the board. In aggregate, our expectation for global growth was at 2.2 percent for 2020, but now calls for a decline of 0.7 percent.
Credit spreads rose across the world, particularly in the high yield market, as a byproduct of the economic damage and liquidity challenges. In fact, high yield spreads roughly doubled from where they were earlier in the year. Historically, the yield-to-worst of high yield bonds has proven to be a strong precursor of subsequent five-year returns in this asset class, an undeniable symmetry. So, spreads at these levels have marked attractive entry points for some investors’ capital.
And we’ve been here before. It’s certainly not the first sell-off we’ve seen. In the severe downturn in 2008, the following year returns in these areas of the bond market ended up being pretty generous once conditions improved.
Turning to equities, the sheer speed of the downturn was breathtaking. Going back fifty-five years in many selloffs, this is one of the fastest on record. It took place in the span of a week. That’s much, much faster than the sell-off during the global financial crisis. As frightening as such a dramatic drop can be, trying to time market bottom is tricky at best. And historically, waiting for the coast to clear after a recession is officially declared over hasn’t been fruitful. Look at the recession of 1981 to 1982. It started in July of ‘81. Stocks then bottomed out about a month later in August. By the time the recession was officially over in November, stocks had rebounded by 16 percent. And that pattern holds up in recessions going back to the late 1930s. Stock markets never wait for the economy.
Casting a wider net for equity markets has proven effective over time. Over the last 10 calendar years, seventy five percent of the world’s top 50 performing stocks have been domiciled outside the US - and that’s an average. Some years the percentage has been in the 90s. So, having a discerning lens in this, in all equity markets, is a sound approach. Given the high level of dispersion we’re now seeing between stock returns, effective stock picking is much more likely to be rewarded in this environment. I know we’ve covered a lot during this quarter, but our timeless advice remains: be global, be selective and be active. Thanks so much. Please stay healthy and we will talk soon.
Capital Markets Outlook: 2Q:2020
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