Winter is... coming?

Publié le 15 Mai 2020Marché et recherche
Winter in... Coming?


Directeur Adjoint des Gestions

[Invest. Pro.] Intended for Professional Clients in accordance with MIFID.

Written by Frank Trividic, Deputy Chief Investment Officer at Seeyond, on 12th of May 2020

The Covid-19 crisis clearly is unprecedented! In fact, there is no example in modern history (since 1945) of an exogeneous event causing a disturbance of such magnitude to the global economic and financial system. In reaction to that we must above all analyze the situation and its consequences on market behavior with humility and cautiousness…

What we already know…

  • The current crisis mostly is a demand shock which impacts Services first. Non-manufacturing activities, which are generally more robust and a dampener of the economic cycle, account for at least two third of global production.
  • Markets have dropped based on anticipations rather than actual data. We are only at the beginning of the economic phase of a crisis that was mainly sanitary until now, and equity fundamentals have just become negative all around the world. Investors’ perception, especially in the US, could change in the coming weeks as the crisis becomes more tangible. 
  • Central Banks and governments have quickly reacted and taken massive measures to provide financial and fiscal support

What we don’t know yet…

  • The level and duration of immunity after a Covid-19 infection
  • The risk of a large and uncontrolled 2nd wave
  • The pace of the recovery depending on deconfinement strategies and on the collective confidence in authorities
  • The impact of the oil price collapse on the credit market and the banking sector
  • The impact of an unprecedented increase in unemployment on global demand

Moreover, some risks appear to be here to stay or bound to increase in the coming months:

  • Tensions around the handling of the Covid-19 virus’ spread by the Chinese authorities
  • The impact on the US elections, with a lower probability of Mr. Trump’s final victory
  • Negotiations surrounding Brexit
  • The lack of unity between European countries

    The current uncertainty can be illustrated by the recent evolution of the Conference Board Consumer Confidence. The pace of the Present Situation index’s fall in April was unprecedented (-91.3 pts, from 167.7 to 76.4) when the Expectations index slightly increased (+5.6, from 88.2 to 93.8). 

Source: Bloomberg / Conference Board, as of April 2020

Source: Bloomberg / Conference Board, as of April 2020

It shows that, for the moment, most Americans believe more in a deep but temporary crisis. Clear-sightedness or denial? It’s difficult to conclude. But, the enormous gap between Present and Future perception can be explained by the exceptional and unknown nature of the crisis which impacts on the economic activity are only beginning.

Equity fundamentals have all turned negative, mainly with earnings momentum and economic growth turning red in March and April. The situation should remain depressed over the coming months, while the reopening of economies will remain very cautious and progressive and analysts will continue to revise earning forecasts downward.

Evolution of the equity fundamentals by main geographic area between 31/01/2020 and 30/04/2020

Seeyond, as of May 12th, 2020

Source: Seeyond, as of May 12th, 2020

One of our main concerns is the tightening of credit, especially in the US. The latest survey from the FED shows a large and violent worsening of lending standards. Historically, this has always been a sign of a deep and lasting downturn in market environment.

Bloomberg, Federal Reserve, as of May 6th, 2020

Source: Bloomberg, Federal Reserve, as of May 6th, 2020

Technically speaking, market regimes have turn bearish in late February. Except for the Nasdaq, our indicators remain in “risky” regime, even though US equity markets are currently provided with a short term support by massive inflows from US retailers and the announcements of partial reopenings. Current market levels are close to breakeven points from which CTA, risk parity and other systematic investors should add risk in their allocation. Valuations however look too far from reality to be sustainable, unless breaking medical news in the coming weeks. 

Seeyond, as of May 12th, 2020

Source: Seeyond, as of May 12th, 2020

The recent rally in US equities is mainly due to new retail traders who rushed out to individual brokerage accounts to capitalize on what they believe could be their last chance to get the bargain on stock markets. In this context, we believe that market recovery could not last very long.

ZeroHedge, as of May 11th, 2020

Source: ZeroHedge, as of May 11th, 2020

Even before the spread of the Coronavirus in China, we warned about the low upside potential in Equity markets (please read So far, so good). And we now estimate that the current valuations, especially in the case of US Large Cap, do not integrate how strongly and how long the Covid-19 could impact global demand and confidence which could then lead to weaker consumption, investments and international trade for the coming quarters.

That being said, we don’t believe either in a Great Depression scenario and in a long lasting Bear market, mainly thanks to large fiscal and financial support (unlimited QE and CARES Act in the US, PEPP in Europe, and so on) that should help limit the 2nd round effect of the crisis.

Which could thus be the game changers for risk allocation?

  • Market valuations that integrate fundamentals and a consistent risk premium
  • A quick recovery in the unemployment rate
  • A significant medical solution (treatment or vaccine)
  • Earnings forecasts and revisions getting more stable

Until those conditions are satisfied, the stock market risk-reward in does not look attractive yet and we should remain on a very cautious stance.

This article has been provided for information purposes only to professional clients as defined in the MiFID Directive. It must not be used for retail investors. The provision of this material or reference to specific sectors or markets in his article does not constitute investment advice or a recommendation or an offer to buy or sell any security. Investors should consider the investment objectives, risks, and expenses of any investment carefully before investing. Views expressed in this article as of the date indicated are subject to change and there can be no assurance that developments will transpire as may be forecasted in this article.