A close look at this week’s trending topic

FAQs – Negative rates to supply chains

Global markets started this week on a stronger footing, with recovery and reopening efforts overshadowing challenging macro data. Since hitting their respective bear market lows on 23 March, the MSCI All Country World Index has climbed 25% and the S&P 500 has risen 28%. After its unprecedented close in negative territory in April, the new WTI front-month contract has climbed back to near USD 35/bbl.

As we start considering what the world will look like after COVID-19, investors would like to know more on the likely macro and asset-class outcomes ahead. Here we answer some of the stand-out questions from our latest livestream event:

1. Are negative interest rates in the US likely?

Federal Reserve Chair Jerome Powell said on 13 May that while the Fed would do what is necessary to assist in the recovery of the US economy, the use of negative interest rates as a policy tool was not under consideration, contrary to what markets are pricing in for the second quarter of next year. We agree with the Fed’s thinking, but even without negative rates, it is clear investors will need to look harder to improve yield in their portfolio, given that high-quality bonds continue to offer very low yields. This may include allocating to riskier credit, such as US high yield bonds, where spreads of 778bps over Treasuries more than compensate for default risks, in our view. Other credit ideas include US investment grade and emerging market USD sovereign bonds. For investors who can implement options, the current elevated volatility means the yield from put-writing strategies is also relatively high. And with rates set to stay low, the arithmetic can tilt in favor of borrowing strategies, meaning risk-seeking investors can also look to boost returns.

2. Will the outbreak of new COVID-19 cases in China deter investors in Chinese equities?

The small number of new cases reported in Wuhan and other Chinese cities, alongside similar outbreaks in South Korea, has prompted concerns about a second wave of COVID-19 infections. But we do not think that small localized outbreaks undermine the investment case for Chinese stocks. The authorities have responded rapidly, vowing to test all of Wuhan’s 11mn residents and imposing renewed restrictions on Jilin City. In our view, China is likely already in the advanced stages of the virus outbreak cycle, while the rest of the world is not as advanced. We expect Chinese equities to lead the recovery, outperforming developed market ex- US stocks. The earnings cycle of the Chinese market, in our view, will reach a trough earlier than that of developed markets, and will recover sooner. For example, we expect 3% earnings growth for China this year versus a double-digit decline for the Eurozone. In addition, many companies in the region are exposed to long-term growth trends such as urbanization and digital transformation. We recommend a diversified exposure across China's onshore A-shares and offshore H-shares and American depository receipts (ADRs).

3. Should supply chains become more local?

The COVID-19 pandemic, arriving on the heels of the US-China trade tensions, has clearly demonstrated the vulnerability of global supply chains. Following the crisis, companies and governments will likely seek to diversify their supply chains and bring them closer to home. We see several longterm beneficiaries of this trend. One is warehouse automation, which we expect to experience structural growth alongside the rise of online shopping. Another is factory automation—companies with automated factories have been able to maintain production through the crisis, a clear competitive advantage. More on automation and robotics here.

4. Is the oil price recovery sustainable?

Futures contract prices for WTI crude oil are back up to around USD 29/bbl after hitting negative territory in April, which created a situation where some holders of futures contracts might have had to pay to have their oil taken away as storage capacity filled up. We believe distortions in oil markets are likely to contribute to continued volatility in markets. But while the market is heavily oversupplied this quarter, we expect it to move toward balance next quarter and become undersupplied in 4Q this year. This recovery should occur as travel restrictions start to be lifted from mid- May, in line with our central coronavirus scenario, and as oil demand picks up in the second half of the year. Hence, we forecast WTI to recover to USD 40/bbl by year-end. This creates investment opportunities in operators in the US energy equity market whose financial position is strong; in the defensive end of the European energy market; and in fixed income, where we continue to see opportunities across almost the entire rating spectrum, with a preference for issuers with low production costs, comparatively strong fundamentals, and access to capital. More here.

5. Does the US market look more shaky after the rally?

Global stocks have been more volatile this week after a range of downbeat headlines on the economic recovery, the reemergence of new cases in South Korea and China, and the extension of lockdowns in some countries and cities. There is also cause for optimism: With over 100 treatments and vaccines under development, a medical breakthrough, a more sophisticated test and trace model, and government support could drive more upside. US legislators are working on another spending bill of USD 3tr. If this were to materialize, we would expect select cyclicals and select pockets of value to outperform. But our downside scenario cannot be ruled out. This could be triggered by a significant second wave of virus cases breaking out, making it unviable to sustainably restart economic activity until the middle of 2021. In this scenario, we would expect the S&P 500 to trade at 2,100 at yearend. To protect against this scenario, we recommend global diversification, gold, and TIPS; a dynamic asset allocation; hedge funds; and structured investments with a degree of capital protection. Nevertheless, with two-way uncertainty still high, we see the best risk-reward in credit, favoring opportunities in US investment grade, US high yield, and emerging market USD sovereign bonds.

Mark Haefele


Bottom line

Global markets started this week on a stronger footing, with recovery and reopening efforts overshadowing challenging macro data. As we start considering what the world will look like after COVID-19, here we answer some of the stand-out questions from our latest investor livestream event.


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