investment insights
What can investors expect in Q4 2020? A more normal pace of recovery
Key takeaways
- The global recovery should continue its course but revert to a more normal pace. Risks nonetheless remain considerable and include the withdrawal of fiscal support in the US, adverse political developments and a turn for the worse on the pandemic front.
- While there are several key differences in their domestic agendas, the immediate economic policy focus for both US presidential candidates will be to support the recovery.
- European growth looks set to slow, with Covid-19 cases on the rise again and the colder months lying ahead – the implications being particularly difficult for high-contact services sectors.
- Comforted by the strong control of the pandemic and V-shaped economic rebound, Chinese policymakers are beginning to focus on their long-term strategy.
- Abe Shinzo’s resignation from Japan’s Premiership will not fundamentally alter the policy outlook for the country.
- Medium-term, we maintain our preference for carry strategies and growth/quality stock markets. That said, following the massive compression in spreads during recent months, carry strategies’ expected returns are declining – making equity investments tactically more compelling.
- The greenback’s September bounce is only temporary – attributable to technical factors and a risk-off reaction amid rising new Covid-19 cases in Europe.
The phase of rapid economic rebound and much stronger than expected activity indicators across all major economies is now over. This is not to say that there is no further cyclical upside – just that the pace of growth will become more normal. Provided, of course, that existing state support schemes are extended, and central banks remain dovish.
In attempting to describe the ongoing recovery, we need first to stress its disparate nature. Employment, for instance, is behaving much better than feared, especially in the US. Conversely, all businesses and economies that are tourism-dependent remain in a deep slump, with little hope of any impending revival (see chart 1, page 04). As for housing, it is firing on all cylinders, supported by all-time low mortgage rates (see chart 2, page 04). This means that further construction activity can be expected and, once these homes have been built, spending on household durables stands to increase.
On the pandemic front, which is so hurting the hotel, restaurant and travel industries, predictions are very difficult to make. The daily count of new infections is clearly on the rise again in Europe (see chart 3, page 04), with countries such as Spain and France particularly impacted, but this has at least partly to do with much expanded testing. Reassuringly, the number of patients requiring admission to hospital and the death rate remain contained. Test-and-trace capabilities, as well as medical treatments, have also improved since the first wave of Covid-19 broke out. And, of course, there is the prospect of a vaccine, perhaps within just a few months. The risk that broad lockdowns be imposed again thus seems limited. Rather we would expect targeted and local measures which, as the US summer experience highlights, do not preclude GDP (gross domestic product) growth.
Overall, then, what further economic upside can be expected? Judging by the still low – but inching up – level of consumer confidence (see chart 4, page 05), and the mirror image in the personal savings rate (see chart 5, page 05), we would argue that the recovery still has a considerable way to go. But, with uncertainty still very much part of the picture, garnering this upside potential will clearly require continued policy support. Not necessarily additional measures, but at the minimum the extension of the current schemes.
On the central bank front, the latest Federal Reserve (Fed) takeaways are two-fold: an extension of forward guidance, with rates to remain at the lower bound through 2023 (which is supportive); and expectations of a full and relatively rapid recovery (unemployment to fall back below 4% by 2023 and core PCE1 inflation to revert back to 2% by 2023), implying that no addition to the asset purchase programme should be needed. In short, the Fed, and other central banks, are determined to drive inflation back up to the target and to enable full employment by keeping their dovish stance for as long as necessary – but not doing more. It follows that, while the rate of change in monetary policy will slow, it is not about to turn negative.
In fact, we would argue that the Fed is somewhat optimistic and might actually find itself forced to step up asset purchases if yields start to rise. As for the European Central Bank (ECB) and Bank of England (BOE), they are likely to take further action, be it additional quantitative easing, more relaxed targeted refinancing longer-term operations (TLTROs) or even, in the case of the UK, a move to negative interest rates.
What about the other leg of macroeconomic stimulus, fiscal support? We attribute the still subdued US consumer confidence in part to the expiry of the USD 600 weekly pandemic supplementary unemployment benefit and the inability of Republicans and Democrats to reach a bipartisan compromise on its extension – or indeed any new relief measures. Although President Trump’s executive orders to distribute a USD 400 per week benefit did provide transitory support, funds are running out and millions of affected households find themselves unsure of their financial situation. Which threatens the outlook for consumer spending and, indeed, the broader economic expansion.
The UK also faced a “cliff edge” this coming October, when its current furlough scheme is set to expire, but a new – admittedly much less generous – scheme has just been announced, covering the November-March period. France and Germany have also extended their job support, covering up to 87% of wages. We have, in the past, been critical of German fiscal policy that, by focussing relentlessly on austerity and excess savings, structurally held back European growth. This year, credit should be given to Germany for using its accumulated fiscal space wisely and finally promoting pro-growth policies.
Overall, thus, we expect the global recovery to continue its course, but revert to a more normal pace. Risks to this outlook are nonetheless considerable and include, beyond the already mentioned fiscal cliff in the US, adverse political developments (US elections and Brexit) and a turn for the worse on the pandemic front. As regards the US elections, both for the White House and Congress, the stakes are especially high for international trade – in particular for the US-China relationship (more on this subject in the US section). With respect to the Covid-19 pandemic, it will be a tug-of-war between the evolution of the daily infection count and fatality rate, and positive news in the global race to a vaccine.
From an investment portfolio perspective, a slowing pace of economic improvement suggests diminishing expected returns. The massive compression in spreads during recent months, in particular, has made equity investments look more compelling today vs. carry strategies on a relative-value basis. Still, an overall cautious stance, aligning portfolio expected shortfall with the benchmark risk, is warranted. Gradual action, too, given that the news flow of the next weeks heralds potentially volatile financial markets.
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