J.P. Morgan Asset Management is pleased to present the latest edition of Quarterly Perspectives. This piece explores key themes from our Guide to the Markets, providing timely economic and investment insights.

THIS QUARTER’S THEMES

The global economy on the mend

Overview

• The global economy suffered a significant injury with the COVID-19 pandemic. A piece of good news is that the worst of the global recession is likely behind us and the economy could expand again in 2H 2020, assuming a second wave of infections is contained.

• With the gradual reopening, the second stage of this economic rehabilitation will be a return to full fitness. This will require a sustainable medical solution, such as a vaccine or COVID-19 testing, and this could take us to 2021 or beyond. The possible revival of U.S.-China trade tensions is also a threat.

• Global central banks have few options left, except keeping policy rates at zero and government bond yields extremely low. Governments may need to dig deeper to support low-income families and businesses.

Growth rate to rebound, but sub-par activity level

The reopening of the global economy should mark April/May as the low point of this recession. But the road to full recovery is long.

• Without a vaccine or efficient testing, the global economy will struggle to make a full recovery. Consumers are likely to continue avoiding crowded places such as cinemas, sports stadiums and concert halls or taking commercial flights.

• We are in the first stage of an economic recovery with some important sectors still far from regaining full strength. This gap implies unemployment rates are likely to stay high, and the threat of bankruptcy persists for companies in these struggling sectors including retail, hospitality, travel and energy. 

Governments and central banks keep the stimulus coming

The scale of monetary and fiscal stimulus around the world is unprecedented.

• Central banks in developed economies have opted for zero policy rates and are engaging more in asset purchases to maintain market liquidity and keep yields low. This first stage of recovery may persuade them to slightly ease the emergency measures, such as reducing the scale of asset purchases. We also do not expect the Fed to push policy rates below zero. A reversal of accommodative monetary policy is unlikely until we are clearly in the second stage of recovery.

• Likewise, governments may need to continue to support households and businesses until the economy is fully back on track. This implies fiscal deficits for 2020 and 2021 should be very high. Developed economies with asset purchase programs and emerging markets (EM) with low government debt should be in a stronger position to keep spending.

An old foe returns

As policymakers and businesses are struggling with the impact of COVID-19, Washington has dialed up its pressure on Beijing via export restrictions on technology products and threatened to delist Chinese companies from U.S. stock exchanges.

• Regardless of the result of the presidential election in November, the relationship between China and the U.S. is likely to remain challenging.

• President Trump has threatened to reintroduce tariffs on Chinese exports, but he must consider the potential negative impact on the U.S. economy and market sentiment. 

• The need to diversify supply chain risks and being close to end-consumers could persuade businesses to diversify their investments across Asia and other emerging markets.　

Investment Implications

• Economic data in 3Q 2020 could rebound slightly as economies gradually reopen. However, given a recession in 1H 2020, economic activities could still be below pre-pandemic levels. It is important to distinguish between the growth rate and the level of economic activities. Renewed trade tensions between the U.S. and China can also upset this recovery. 

• Given the gradual recovery, we expect governments will need to introduce more economic stimulus in the coming months to support households and businesses. Developed economies, alongside central banks’ asset purchases, and economies with low government debt (mainly Asia) should be in a better position to spend. 

• Yields are likely to stay low and the hunt for income should intensify. With the global economy stabilizing, investors could seek yields in both equities and fixed income.

Avoid tunnel vision when it comes to income

Overview

• Optimism over economic reopening has driven a return to risk-on mode for markets, while the flight to safety has fallen out of favor. However, a potential return to normality does not mean that fixed income is sidelined. The path to recovery is still uncertain and wobbly. 

• The hunt for yield will likely persist. Key rates and sovereign yields are low and will likely remain so with expansionary monetary policy. We see value in concentrating on those countries or sectors we believe have stronger fundamentals and lower chances of default.

Emerging challenges

Emerging markets have gradually fortified their financial position and are no longer as vulnerable as they were in the past. But the COVID-19 pandemic has brought new challenges.

• As lockdown measures brought economic activities to a halt, governments around the world have rolled out some unprecedented spending programs to cushion the fallout. 

• EMD offers higher yields, making it attractive in this low-yield environment, and this could continue for some time. But greater government spending from their fiscal programs will put renewed pressure on budgets and borrowing costs.

• We would be wary of countries that had difficulty controlling fiscal deficits and face the prospect of sovereign rating downgrades as more spending exacerbates pre-existing issues.

IG back-up

With their lower volatility, IG bonds can help buffer some of the current growth concerns and bouts of risk aversion.

• The outlook remains uncertain as the world slowly recovers from the COVID-19 pandemic, but higher-quality IG bonds can still provide some shelter.

• Major central banks including the Fed and ECB have stepped in to explicitly support IG bond markets directly. Some Asian countries, such as Indonesia, South Korea, and Thailand, are also considering plans to adopt these unconventional measures. This sizeable support does not mean an absence of downside risk, but it does make IG bonds more attractive despite lower yields.

High yield, high default

The pandemic adds some complications that have made us more cautions on HY fixed income.

• We are likely to see a number of rating downgrades and defaults because of COVID-19 control measures. A prime example is the energy sector, which has seen its prospects seesaw back and forth after the plunge in oil prices, the collapse in demand and disagreements among producers.

• Compared with the IG sector, the HY sector is unlikely to benefit as much from policy support. Most HY-issuing companies will not qualify for the support packages offered by governments and central banks. We are increasingly aware of the potential downside risks, but spreads historically peak before a defaults. With spreads coming back down, most of the negative news should already be priced in. Selection will be key in avoiding the most troubled sectors.

Investment Implications

• Our current outlook is for monetary policy to remain very accommodative for the next several months. The Fed and the ECB will likely extend and expand their quantitative easing programs later this year. Other countries appear to be considering using similar unconventional policies to directly buy bonds to support liquidity and debt markets. Risk-free rates are likely to remain near record lows, prompting investors to seek yield by taking on more credit risk or liquidity risk.

• Governments have rolled out unprecedented fiscal support measures. The sizeable government spending is likely to put pressure on fiscal budgets and borrowing costs as issuance increases. We would be wary of sovereign bonds in countries facing possible rating downgrades. 

• High yield bonds may be less attractive in this current environment where we expect rising defaults, but active selection can help investors avoid the troubled sectors.