And other questions on the minds of investors.

Our Top Market Takeaways for April 24, 2020.

Spotlight

5 questions on investors’ minds

Markets continue to feel more “normal.” Major equity indices were down 1%–2% on average, U.S. sovereign bond yields drifted mildly lower, and credit spreads were a bit wider heading into Friday. There wasn’t that much movement in markets, given what happened this week: Congress passed another ~$500 billion bill that shores up more money for the Payroll Protection Program, among other things; another 4.5 million Americans filed for unemployment; West Texas Intermediate crude oil traded negative; and it seems like Remdesivir’s first trial was a flop. What did we miss?

This barrage of information inevitably raises questions. Below, we focus on five in particular that are weighing on investors’ minds, ranging from how much longer this will last to what can we learn from an earnings season that CFOs are conducting from their kitchen counters.
 

1.    When will the U.S. economy reopen?

Based on projections from the Institute for Health Metrics and Evaluation (IHME), it seems like 30 states should be able to ease coronavirus-related restrictions in the month of May. These states made up a little more than 60% of total GDP in 2019. However, we should note that the IHME assumes states will ease restrictions when active COVID infections drop to the rate of one infection per one million people. In reality, it seems like some states may not be so conservative. For example, Georgia and Texas seem keen to relax restrictions even as their daily new case growth trends have barely shown signs of rolling over.

Line chart shows the IHME projected relaxing of social distancing measures across the United States from April 30, 2020, through July 2020.

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Our Chairman of Market and Investment Strategy, Michael Cembalest, recently published some thresholds that he believes are reasonable for state policymakers. Even though Georgia’s new case curve is still early in its decline at best, the state passes both Cembalest’s testing metric and new case metric. Only four other states (Maine, Michigan, Louisiana and New York) are currently passing both tests.

Overall, it seems like May and June could be the “reopening months.” This does not mean that the United States will be “back to normal” by July. The new normal will most likely be characterized by social distancing practices, bans on large gatherings and events, continued isolation by vulnerable individuals, etc. However, relaxing restrictions is certainly a step in the right direction as long as possible second waves are kept in check by robust testing and tracing efforts.
 

2.    How did Asian countries have relative success at containing the virus?

A number of Asian economies have now successfully contained the initial COVID-19 outbreak. Here, we consider the examples of China, Korea and Taiwan—all of which have “flattened the curve,” albeit with very different approaches:

  • China: First hit by the virus, China didn’t have the chance to play defense. Once it mobilized, China implemented quarantine restrictions among the most restrictive seen to date globally. Domestic flights and other transportation were reduced or restricted, mobility between neighborhoods was limited, and all non-essential businesses were closed. It also implemented technology-enabled contact tracing.
  • South Korea: While implementing little mobility restrictions, Korea employed mass, indiscriminate testing and relied on innovations, such as drive-through testing and technological contact tracing. According to the Korea Centers for Disease Control, Korea has the highest testing per capita across the world.
  • Taiwan: Similar to South Korea, Taiwan imposed minimal mobility restrictions and almost no business suspensions, except for extending school winter breaks and prohibiting entry from foreign nationals. Taiwan has been an example of prevention, rather than suppression, of the outbreak. The island’s Centers for Disease Control contacted mainland authorities and the World Health Organization (WHO) about the then-unidentified virus as early as December 31, and employed a response mechanism to track down its first confirmed case on January 1.

Graphic of the world map indicates the COVID-19 containment measures imposed during the COVID-19 pandemic. The graphic highlights these efforts from coloring countries as moderate, intermediate or severe in their containment measures, as of April 16, 2020.
The greatest contrast is perhaps seen in the economic impact. The economic lockdown in China caused a far more devastating slowdown in economic activity, whereas Korea and Taiwan went on different paths and suffered a far less severe economic impact.

Line chart shows the industrial production year-on-year % growth as a two-month moving average for East Asian economies from 2014 through March 2020. It compares Taiwan, South Korea and Mainland China, indicating that South Korea and Taiwan suffered a less severe economic impact.

As countries around the world are now looking at how to restart their economies, it will be important to understand the lessons learned from experiences in Asia. Encouraging a broad adoption of social distancing practices, massive testing, aggressive contact tracing and isolation, and adoption of technological solutions to trace the spread and enforce quarantines could allow countries to suppress outbreaks without resorting to full-scale shutdowns.
 

3.    What might change after COVID-19?

Despite fears that “the world will never be the same” after COVID-19, less may change for investors than many assume. For example, the next cycle will likely have many of the same characteristics as the last. We face a deep recession and hard road to recovery. The result will likely be reasonable but not spectacular growth, gradually rising earnings, rapidly subsiding corporate default rates as growth is re-established, very low bond yields and, eventually, a return to full employment. Sound familiar? This is what we witnessed for much of the last decade.

Some already existing trends may accelerate. For example, geopolitical tensions may increase and supply chains may get even shorter. Thanks to the recent trade war, firms already were questioning concentrated centers of production. The pandemic is likely to further pressure corporations to consider a supply chain either in their home countries or in closer, more stable trading partners. Additionally, megatrends—like digital transformation, healthcare innovation and sustainability—look poised to gain even greater traction. The pandemic has already accelerated our move from the physical to the virtual world. More focus is also already on innovating to provide treatments and vaccines against viruses such as COVID-19. The crisis also may be the making of ESG investing, as there is growing evidence that ESG-focused funds outperformed during the COVID-19 bear market.

Lastly, some things will undoubtedly change. For example, the fixed income market looks set to undergo a major transformation. Investors were plagued early in this crisis by a severe lack of liquidity, and unprecedented central bank action swiftly worked to provide a remedy. If a more permanent solution isn’t found, future sell-offs could bring further disruption and again require massive central bank intervention. We’ll likely see significant reforms in the years ahead.

You can dig deeper into these dynamics in our latest article, What will investing look like after COVID-19?
 

4.    Will oil prices go negative again?

Let’s back up. Earlier this week, West Texas Intermediate (WTI) oil contracts for delivery in the month of May traded at negative prices for a couple of hours right at the end of the life of the contract. We explained this in our note on Tuesday, but basically some market participants were forced to pay to get out of actually accepting physical oil. Usually investors with extra storage space are able to buy contracts for delivery and then can sell that oil later for a profit. Because demand for oil has been destroyed by the COVID-19 shock, everyone’s storage space seems to be full—some estimates suggest there are 3.2 billion barrels of oil sloshing around in storage globally.

So could we see this repeat? Negative prices for WTI could happen again as we get closer to the expiration of the June contract later in May, but we don’t think it’s likely.

We expect supply and demand to better balance over time. In the short term, this recent market event is likely to take some supply offline as the higher-cost producers find it economically unreasonable to continue production. In the medium term, COVID-related restrictions are likely to ease in the coming months, which should increase demand for crude. This is reflected in the oil futures curve. For example, WTI for July delivery is currently trading at $22 per barrel.
 

5.    What have we learned from earnings season so far?

There is only so much you can learn from a backward-looking report when the whole world has changed, but it is clear that the pandemic is taking its toll. A little more than 20% of S&P 500 companies have reported thus far, and consensus estimates for the full quarter continue to drop—the street is now expecting a -15.6% contraction in earnings per share this quarter versus one year ago. Even as these negative revisions set the bar lower and lower, 67% of companies that have reported have beaten earnings per share estimates, in line with the historical average.

That said, as we discussed earlier this week, it’s a tale of two markets right now: one comprising the companies that investors believe can survive (and perhaps even thrive) during the pandemic, and one comprising companies that are severely impacted by the economic shutdown. It’s sure to be a challenging quarter overall, but investors seem to have accepted that, and they are looking to the future. The big question that remains is, for how many quarters beyond this one will companies have to fight COVID-related headwinds? 

 

 

All market and economic data as of April 2020 and sourced from Bloomberg, FactSet and Gavekal unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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