The global economy will not see full recovery until 2022, says Bank of Singapore (BOS) analysts Eli Lee and Conrad Tan, with the bank’s economics team predicting a base case of an incomplete 4.4% growth rebound in 2021.
Investors, meanwhile, should fasten their seatbelts as markets reach a crossroads in 2H2020, with a pivotal US Presidential Election in November and growing US-China tensions in the backdrop of greater guidance over Covid-19 recovery.
While global growth is likely to shoot up sharply from a low base, Lee and Tan caution against overoptimism about a potential “V-shaped” recovery. “In our base case, the reality of a drawn-out recovery process will be in tension with the optimism in markets today, and already we are beginning to see signs of growth momentum plateauing,” the pair argue in a broker’s report released on August 3.
Economic recovery has already begun slowing down. After 15 weeks of consecutive declines in initial jobless claims numbers to 1.3 million from its peak in March at 6.9 million, US unemployment figures have risen over the last fortnight. The Conference Board Consumer Confidence index fell to 92.6 in July, after three straight months of increase to 98.3 in June.The pace of economic normalisation in China has begun to moderate owing to headwinds from global economic weakness.
Fortunately, the BOS duo does not expect rising infection trends to lead to another round of widespread shutdowns. While a resurgence in infection rates in various hotspots has hampered recovery momentum in the US, the overall rate of new cases has begun to decline. Though a subdued death rate and weakened political wills avert another round of nationwide lockdowns, the pace of economic recovery will remain patchy until an effective vaccine emerges.
The Fed is also likely to continue monetary expansion, having resolved to continue doing “whatever it takes” to support the recovery in July. This liquidity injection has been key to stabilising markets and providing backstops amid present volatility. Lee and Tan expect further monetary expansion in 2H2020 after the Fed reiterated their commitment to near-zero interest rates via an ‘average inflation targeting’ framework, especially with presidential polls imminent.
Congress is also likely to deliver another round of fiscal stimulus before the August Recess after a historic EUR750 billion ($1.21 trillion) stimulus passed by the EU. The final package is expected to be worth US$1-3 trillion. A sticking point, however, is Republican reluctance to finance the extension of US$600 ($825.14) weekly unemployment benefits which expired in July, though the BOS duo believe that a bipartisan compromise will eventually be reached.
Based on this scenario, Lee and Tan see the long-term destination for risk assets leaning more towards the upside. At the moment, risk asset prices are reflecting significant near-term optimism. Yet, significant uncertainties remain, including the impact of the result of the US Presidential elections and the potential risk of a US fiscal cliff could see the coming months being fraught with volatility.
“For leveraged multi-asset investment portfolios, managing liquidity buffers and volatility will be key to navigating the landscape ahead,” the pair report. This is especially true for an ultra-low interest rate environment, as the increased correlation between stocks and bonds will make it more difficult to manage volatility in multi-asset portfolios. Both stocks and bonds will be driven by equity and credit risks, respectively, which are positively correlated, add Lee and Tan.
“Historically, when stocks fell, US Treasuries which are safe havens would rally – which in turn result in US Treasury yields falling. As bonds are spread products priced off Treasury yields, taking all else constant, they would benefit from falling yields and rise in price. With rates now at ultra-low levels, however, with very limited room to fall further, the efficacy of this mechanism is now limited,” the broker’s report continues.
Investors are therefore encouraged to diversify their portfolios and incorporate hedges into them. Aside from traditional safe havens like gold, which is currently highly-priced, Lee and Tan also encourage investors to explore currency pairs. Going long on the Japanese Yen versus the Australian Dollar over 2H2020, for instance, can be an effective hedge against volatility associated with a second-wave of Covid-19, uncertain economic recovery and a tumultuous US Presidential election, they suggest.
The analysts also see 2H2020 as an opportune time to rebalance their portfolios from growth and momentum stocks into cyclical and value plays. The more resilient balance sheets and stable business models of the latter are likely to benefit from the long-term economic recovery and better survive present volatility. Currently, the performance of value stocks relative to momentum stocks remain at year-to-date lows, with Lee and Tan seeing value plays benefitting from an anticipated return to average over time.
A renewed emphasis on value and cyclicals can also help hedge investment portfolios.“An analysis of the performance of value and cyclical equity segments over the last two years show that they have historically displayed a more positive correlation to rates (and more negative correlation to bonds) versus growth and momentum segments, and this can contribute to further diversifying and hedging portfolio concentration risks,” remark the BOS duo.
