The first half of 2020 has perhaps been the most chaotic time for the global economy for the past three decades, with significant unknowns eating away at investor confidence. As scientists struggle to develop a vaccine to bring the world out of the damaging Covid-19 pandemic, the world shakes in fear as US-China ties grow ever more acrimonious. The international community still struggles with the long-term threat of climate change and unsustainability.
To help investors navigate an uncertain 3Q2020 in one piece, BOS has been identifying key trends that investors should consider as 1H2020 comes to a close. Below are five themes that will shape the global investment environment over the next three months.
US-China Decoupling
Beijing has no friends in Washington, says Eurasia Group’s Robert Kaplan. The only thing that Democrats and Republicans -- who feel only rancour and ill-will towards one another -- can agree on is that China is a threat to America. BOS sees US public sentiment on China steadily souring and expects more US aggression towards China before US elections in November.
“As we enter the second half of the year, both countries continue to spar verbally and engage in tit-for-tat actions, including visa bans on blacklisted officials,” warns the BOS report, which highlights that the dispute between the world’s two largest economies now covers a wide range of issues from healthcare to capital markets. In the context of a weak global economy, such disputes could slow the recovery of the global economy and reshape the world’s supply chains.
In particular, the US-China technology war will only escalate going forward and deepen the trust deficit between both powers. With the US Bureau of Industry and Security (BIS) banning Huawei from using US software and technology to manufacture semiconductors, China’s rollout of 5G could be severely affected seeing as Huawei owns a substantial share of China’s 5G base stations. Such an interruption has severe implications on the broader technology complex.
Tensions have also manifested in the listing of ADRs of Chinese companies in the US and allocation of US funds into Chinese investments. If the US government enacts the Holding Foreign Companies Accountable Act, IPOs of Chinese ADRs in the US could become more difficult -- especially for young, unprofitable firms -- and accelerate listing of large-cap ADRs outside of the US. President Trump is also exerting pressure on Chinese investments by ordering the Federal Retirement Thrift Investment Board to defer the implementation of a new, China-inclusive index for its international fund initially planned for June 1.
All this is coupled with intense geopolitical disputes over China’s claims over the South China Sea, the Taiwan Straits dispute and the autonomous status of Hong Kong under “One Country, Two Systems”. Expect heightened political and geopolitical risks in the near future.
US Presidential Elections
With US presidential elections in November likely to be pivotal to both markets and the broader global order, the imminent polls are likely to be a source of market volatility over the next few months. Key election issues include the scale and duration of additional fiscal support to avert an impending fiscal mini-cliff in the US.
At present, four emergency programmes worth US$1.5 trillion passed in 2Q2020 reach their expiry date at the end of the month. It is likely that another stimulus package will be passed, but negotiations in the legislature have only just begun following the end of a senate recess on 20 July. Senators will be horse-trading and hardballing for maximum political gain with an eye to the polls, aiming for a politically-advantageous timing and structure for the eventual package.
“A November win by Democratic presidential contender Joe Biden with a Republican Senate and Democratic House would likely be the best scenario for markets over the long term,” says the DBS team, who sees a more stable approach to US-China relations from a Democratic administration coupled with the preservation of Trump’s tax cuts under a Republican senate.
A second term for Trump is the second best option, says the BOS team. They see a “Blue Wave” as unfavourable for investment as Democrats have promised to pass higher corporate and capital gains taxes should they win both congress and the White House. Betting markets see a “Blue Wave” as the most likely scenario, with US election results usually becoming a market driver in the second half of election years.
“As we move through Q3 2020, rising odds of a feared Democratic sweep of the White House and Congress might prove to be a stumbling block for risk assets that have so far been supported by unprecedented stimulus from policymakers and optimism over the post-pandemic economic rebound,” adds the report. Green energy and renewables are likely to perform strongly under a Democratic administration while oil and gas could lose market share and profit.
Unprecedented Economic Stimulus
Policymakers are determined to maintain expansionary fiscal and monetary policy going forward. “Given the uncertain path back to a full economic recovery, we expect the Fed to keep
rates at near zero for up to the next five years, and to maintain a flexible stance towards asset purchases in an effort to ensure that rates at the long end of the US Treasury yield curve remain low,” says the BOS report.
The flipside of this unprecedented fiscal stimulus is much higher debt levels and pressure on national borders as states struggle with the economic costs of fighting Covid-19 and economic recovery. Expect higher fiscal deficits and upward pressure on tax rates as governments seek to rebalance the books. Financial sustainability will be an increasingly important long-term issue, especially for countries with a high twin deficit and those which issue debt in foreign currencies.
While the high amount of liquidity in the market could mean that the long-term market implications of this stimulus could take a while to manifest, excessive monetary easing and blurring of fiscal and monetary policies towards debt monetisation could lead to hyperinflation and debasement. Structural forces like demographics and technology could anchor inflation, however, especially since there is no alternative to the US Dollar as the global reserve currency.
“Going forward, we see major central banks keeping rates low to bolster the post-pandemic economic recovery and to escape the gravity of a lowflation trap,” notes the BOS report. The hunt for yield is expected to be a key market driver going forward, underpinning BOS’s constructive long-term view towards emerging market high-yield bonds.
The Covid-19 Recovery
It is almost a cliche now to say that Covid-19 will forever transform the global economy. More robust technology platforms will be needed to facilitate remote working while firms will look to reduce concentration vis-a-vis customer and supply chain risks, with e-commerce, digital entertainment and leisure, and telehealth expected to benefit.
Businesses will also seek to strengthen balance sheets with more liquidity, long-term funding and lower leverage. Sadly for investors, this balance sheet strengthening could lead to lower dividend payouts. BOS sees more share buybacks and capital expenditure, as well as more capital raising from investors.
“As some poorly capitalized companies struggle to recover, we can also expect to see consolidation and restructuring in sectors that are badly affected by the virus outbreak,” it adds. Hotels, gaming/casinos, retail and office real estate, energy, airlines, and autos will come under increasing pressure in the wake of the pandemic.
The revival of sustainability
Covid-19 has put the world on notice - no longer can businesses assume that they can get away with unsustainable business practices without facing a reckoning. The pandemic has exposed deepening inequality in wealth, living conditions and access to public goods and daily necessities. Firms have suffered operational risks from the lockdowns and see their supply chain, human resource and crisis management policies severely tested.
“We see the crisis accelerating emerging trends in ESG and we expect the heightened focus on businesses’ environmental and social impact to persist long after the crisis abates,” writes BOS. The need to fight climate change heralds regulatory risks for fossil fuel businesses, as well as greater consumer and environmental pressures to conduct business sustainably. Firms must adapt or perish in a market where sustainability is more important than ever.
Still a growing emphasis on sustainability presents significant business opportunities for firms. Adapting to this “new normal” will lend them a first mover advantage in an economy that will liley become more conscious about sustainability. With business and government seeking to “build back better” and promote green recoveries, higher quality ESG standards and more ESG-focused products will allow investors the opportunity to align their portfolios more closely with their own sustainability preferences and goals.
“Sustainable funds in the United States set a record for flows in 1Q 2020, and estimated net flows for the 314 open-end and exchange-traded sustainable funds available to US investors reached USD10.5 billion in the first quarter, eclipsing the previous quarterly record set in 4Q2019,” observes BOS. Assets under ESG mandated funds have also grown strongly.
