Could a second wave of outbreak derail economic recovery?
A number of countries have seen a pick up in new infections in recent weeks. Instead of derailing the global economy and forcing another dip in economic activities, the latest outbreaks are more likely to dampen and delay the global economy making a full recovery.
In the U.S., the daily number of newly infected accelerated since mid-June and is averaging around 60,000-65,000 per day. Meanwhile, Latin America and South Asia are also struggling through a rise in new cases since the outbreak began. A number of economies, such as Hong Kong, Japan and Spain, have also recently experienced a rebound in the number of cases. In the case of Hong Kong and Japan, the new infection numbers are only in hundreds, but this is already higher than the first wave in March and April.
Looking at mobility data (see Exhibit 1 below), the latest outbreak across the U.S. has forced the public to cut back on their activities, as a number of states have paused, or even reversed, their plans to re-open their economies. Europe’s numbers are still improving, but the numbers from Spain may start to show decline as more social distancing policies are put back in place.
There are a number of factors that can help prevent the global economy from revisiting the lows in late 1Q/early 2Q. More government fiscal stimulus should be on the way. The new EUR 750billion European Union recovery fund will provide additional firepower to European governments to support their economies. The U.S. Congress is expected to pass another fiscal package in coming weeks. Americans could receive another check of up to USD 1,200 and enjoy an extension of evictions moratorium. However, it is not yet clear whether the USD 600 per week extra unemployment benefit would continue.
Governments are also gaining experience on how to manage a new wave of infection. Instead of a national lockdown or a draconian stay-at-home order, it can strike a better balance between containing the outbreak and permitting some essential economic activities to continue.
Businesses are also finding ways to resume operation where possible. Some companies are allowing their staff to work from home. Others have set up systems to ensure staff and customers can stay safe from infections. Many have also adapted their business models in the time of social distancing, even though some sectors will not be able to resume normal service until the pandemic is truly under control, such as airlines, travels and entertainment.
As we have argued in the past, a full recovery to pre-pandemic level of economic activities will require a sustained solution to the COVID-19 pandemic, such as widely distributed vaccines. Until then, the best of the stage one recovery is probably behind us and the improvement in months ahead is likely to be gradual.
EXHIBIT 1: GLOBAL MOBILITY
The latest round of outbreak in Europe and Asia does not change our view on portfolio construction and asset allocation, as this is in line with our view that the first stage of economic recovery will be bumpy until we find a vaccine.
With more rounds of fiscal stimulus in the pipeline, developed market central banks are expected to keep their asset purchases and maintain low government bond yields. This leaves investors with few choices but to generate income from riskier fixed income assets, such as high yield corporate debt and emerging market fixed income. The recent weakness of the U.S. dollar should also benefit the latter.
For equities, 2Q U.S. corporate earnings have been better than expectations so far. Over 70% of the companies that have reported so far printed earnings that beat analysts’ forecasts. Investors are also expecting a solid turnaround in 2021 and 2022. Hence, the horrendous 2020 earnings, and the near-term downside risks due to the second round of infections, may not deter investors too much. This is especially true given the rich valuation in government bonds.
That said, in both corporate debt and equities, active selection is still crucial given different sectors’ variance in earnings and balance sheet fundamentals. Many are concerned that valuations in outperforming sectors, such as technology and healthcare, are already high. While this may be true based on the next twelve months’ earnings, we think these sectors continue to represent attractive opportunities in the post-pandemic world, as many of the consumer behavioral shifts in favor of these sectors could be permanent.