BlackRock Commentary: Gauging the virus shock to economy

Jean Boivin, Head of BlackRock Investment Institute together with, Elga Bartsch, Head of Macro Research, Mike Pyle, Global Chief Investment Strategist for APAC and Nicholas Fawcett, Member of the Economic and Markets Research group all part of the BlackRock Investment Institute share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Global economic activity is being frozen to stem the coronavirus pandemic. Yet implications for asset prices will depend on the cumulative impact of the growth shortfall over time. BlackRock believe that policy actions to cushion the impact of virus shock are nothing short of a revolution. Execution is a risk, but if successful, the cumulative impact of the virus should be well below that seen in the wake of the 2008 global financial crisis (GFC) — despite the historic scale of the initial shock.

2020.04.27 Article image 1

Sources: BlackRock Investment Institute, with data from Refinitiv and IMF, April 2020. Notes: We show the estimated cumulative shortfall of GDP in the U.S. and euro area as a share of 2019 GDP levels as implied by the median (green dots) and most pessimistic forecasts (yellow bars) in a Reuters poll of 41 forecast for the U.S. and 29 for the euro area, published on 22 April 2020. The red financial crisis bars show the total shortfall accumulated between 2008Q3-2019Q4, expressed as a share of 2007 GDP. There is no guarantee that any forecasts made will come to pass. These hypothetical scenarios are subject to significant limitations given the uncertainties surrounding the virus outbreak.

A banking crisis and overextended household balance sheets led to a “lost decade” of deleveraging after the GFC. This time, the immediate shock is much deeper, but the financial system is not in crisis for the moment. The propagation of the shock is directly linked to the evolution of the virus and the duration of containment measures, in our view. Long-run economic forecasts, including the most pessimistic, imply economic consequences that are much less severe than the post-GFC impact in both the U.S. and euro area, as the chart shows. The cumulative GDP shortfall in the years that followed was ultimately equivalent to 50% of 2007 GDP in the U.S. For the current shock to be on a similar scale, it would have to morph into a financial crisis, in our view. For now, we see the much swifter and greater fiscal and monetary response this time stemming this risk.

The pandemic has triggered an abrupt, deliberate stop to economic activity. We believe the concept of “recession” doesn’t’ apply here because this is not resulting from the evolution of a usual business cycle. See details in how large is the coronavirus macro shock? The current shock is more akin to a large-scale natural disaster that severely disrupts near-term activity, but eventually results in an economic recovery. The large and immediate loss of income needs to be addressed with a comprehensive policy response, including a new suite of policy measures designed to help bridge cash flow pressures by backstopping household incomes and small businesses – without which the economy could suffer permanent damage. We have seen these measures – both monetary and fiscal – coming together quickly and on unprecedented scale, especially in key developed economies. Policy coordination is critical, as we wrote in time for policy to go direct.

A key risk to our view is policy execution. A recent example shows the difficulty of delivering the aid to those in need: A $350 billion loan program for distressed small businesses in the U.S. quickly reached its limit, with evidence that the smallest businesses had severe difficulty accessing the program. There is also the risk of permanent damage if the freezing of economic activity lasts for an extended period of time – especially if ongoing policy support loses momentum. An extended interruption could morph into a financial crisis if it were to lead to an unprecedented wave of corporate insolvencies, putting pressure on the banking system. Last week’s oil price collapse – partly caused by the ongoing drop in demand caused by the economic contraction – illustrates the outsized near-term knock-on effects of halting economic activity.

Bottom line: The initial risk asset response in 2020 – with equities down 30-40% across the world – has been on an order of magnitude similar to the financial crisis. We see the lasting impact of the current economic shock as less severe given much greater fiscal and monetary support this time around. Yet effective implementation of such policy support is critical, and we remain cautious over a tactical horizon due to the substantial near-term uncertainty on the evolution of the virus and containment measures.

Market Updates

2020.04.27 Article image 2

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, April 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.

Fiscal and monetary policy action to bridge the economic impact of the  coronavirus has taken shape – and now the key is policy execution to ensure households and businesses get the cash being promised. Oil prices crashed last week amid plunging demand and a surging demand for oil storage, dragging down other risk assets such as stocks. The U.S. launched an additional $484 billion relief package, including a $321 billion top-up of its funding for small businesses. That takes the fiscal support passed by Congress to nearly $3 trillion in the past two months.

Week Ahead

 

  • Tuesday: U.S. consumer confidence
  • Wednesday: U.S. preliminary Q1 GDP, Federal Reserve rate decision
  • Thursday: China official purchasing managers’ index (PMI); euro area flash GDP, European Central Bank rate decision
  • Friday: Manufacturing PMI for Japan and the U.S.

This week’s U.S. consumer confidence data will be in focus. Consumers have tended to play a stabilizing role during past economic downturns. Many of the social distancing measures to contain the pandemic specifically target consumers’ activities, such as dining out and shopping. Consensus estimates point to the consumer confidence index plunging to a four-year low.


 

BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 27, 2020 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL



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Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Last week global equities were weaker overall on what turned out to be a rather interesting week in terms of newsflow. The MSCI World Index finished down 1.5%, the S&P 500 Index was down 1.3%, the STOXX Europe 600 was down 1.2% and the MSCI Asia Pacific was down 2.3%. Headlines remain mixed as we progress towards some kind of loosening of the COVID-19 lockdowns. Toward the end of last week, it became apparent that we may be waiting for longer for a vaccination after Gilead announced its antiviral drug had suffered a setback during its first trial. Outside of that, the key headline was in the energy sector as oil prices moved into negative pricing for the first time in history.

Update on the COVID-19 Situation

Last week, we saw a number of regions tentatively moving towards easing lockdowns amid declining infection and death rates. It appears that Germany and Italy have peaked. Spain saw an uptick again in coronavirus cases last week, but it remains largely on a downward trajectory.

In terms of UK data, it is worth noting that whilst we may have seen a  peak, the daily deaths in the United Kingdom are estimated by some to be much higher, as the official figure only includes deaths occurring in hospitals. Whilst there are falling death tolls across Europe, we are still far from understanding what recovery looks like, both socially and economically. We have seen some analysis that a return to 2019 levels for hotels could take at least six years, in a clear sign of just how drawn out this has the potential to be.

Oil Pricing Drama

Last week was an historic week for the oil market as we saw prices fall into negative territory for the first time. With the physically settled May West Texas Intermediate (WTI) futures due to expire on 28 April (for May delivery), holders began to sell out of their positions at any cost late on Monday, trading as low as -USD$40 per barrel at one point. This all centred around capacity issues, due to WTI being landlocked supply. WTI is stored in Cushing, Oklahoma, and with inventories rising at a rate of 6-7 million barrels per week, storage at the facility in Cushing will soon be near capacity with no room for additional oil supply.

As an example of the selling pressure on Monday last week, the United States Oil ETF (USO) held around 25% of the outstanding volume of the May WTI futures contract, a sizeable holding. Thus, as holders such as USO looked to sell out of their positions, and with a material lack of physical buyers at this time, prices in the May futures contract plummeted. (Futures contracts represent an agreement to buy or sell a commodity at a specified price at a date in the future.)

Despite the headlines, the extreme move to <USD$0 was only limited to one futures contract. Whilst the WTI and Brent oil June futures contracts did hit lows of ~US$6.50 and US$16 respectively last week, they have since recovered. We certainly are in unprecedented times as oil markets try to digest an overwhelming drop in demand combined with storage facilities nearing capacity—leading buyers to figure out where to store the oil upon delivery.

As OPEC+ countries start to make cuts to production in the background, naturally, focus remains on when to expect that return of demand. The third quarter has been cited as the period we might expect a sharp recovery in demand as lockdown guidelines loosen and people get back to work on some level. Of  course, the return to some level of normalcy relies on the continuous management of contagion on a global scale.

The oil and gas sector in Europe has been notably volatile of late, with stocks in the sector regularly coming in as the daily underperformers or the outperformers over the last few weeks. The sector was one of the outperformers in Europe last week, but remains the third-worst performing year-to-date.

European Union Eurogroup Meeting: Recovery Fund Welcome, but Detail Lacking

Last week’s Eurogroup meeting had fine intentions, with leaders agreeing to the creation of a COVID-19 recovery fund. We saw European equities initially rally, but there was no clarity on the size of the fund, nor a clear decision on whether it would disburse its cash to troubled governments through loans or grants.

We have talked a lot about “coronabonds” in recent weeks. These did not materialise given the pushback from Germany and the Netherlands (as expected), but the joint recovery fund agreed to will hopefully diffuse the political tensions that had been rising around the refusal from the likes of Germany and the Netherlands to agree to jointly issued bonds. However, reports that several governments were opposed to a generous package suggest that reaching an agreement on the specifics may be difficult. A package involving grants would likely ease tensions (and Italian yield spreads), but a package involving loans would be less likely to.

In terms of financing, the preferred option, according to The Multiannual Financial Framework (MFF), seems to be to increase the long-term EU budget, but there are no details on how the budget would be increased. The group is expected to meet on the 6 May to work on the details, but the fund will not hit the economy until 2021. We could be looking at a drawn-out period of negotiation. Still, Italian Prime Minister Giuseppe Conte welcomed the creation of the fund as “great progress, unthinkable until a few weeks ago”.

Corporate Themes

Another theme we were watching last week was the high number of corporate placings, particularly in the United Kingdom. The investor appetite is certainly there for these, with very tight pricing in most cases. Also on the corporate front, the Financial Times reported on concerns that US banks are retreating to home territory, becoming highly cautious over lending to European companies. As an example, JP Morgan recently pulled out of talks over an additional credit line for BASF. This could prove important given current liquidity concerns.

Week in Review

Europe

European equities were broadly lower last week with headlines on COVID-19 developments, the unfolding oil pricing drama, and the Eurogroup’s meeting last week all at play. First-quarter (Q1) earnings season also kicked off properly in Europe, and we had some rather ugly economic data.

On the equity market front, the United Kingdom was the relative outperformer (albeit still down),  helped by the weaker pound. Italian equities were also helped into the end of the week,  by the more conciliatory response from the Eurogroup, with the Italian banks finishing up on the week. Spanish equities lagged on the week after they saw a return to growth in their COVID cases.

In terms of sectors, it was the year-to-date outperformer which won again for obvious reasons, health care. Equities in the oil & gas space showed some resilience too, despite oil prices being buffeted around, with the sector also finishing up. At the other end, it was travel and leisure which lagged, as all indicators pointed to a very slow and labored recovery for the sector. Retail stocks also remained under pressure, with most of Europe still in strict lockdown. Notably, the eurozone’s luxury stocks got hit again.

Macroeconomic data last week was particularly grim, with April Purchasing Managers’ Index (PMIs) sending a bleak message. Services PMIs fell to between 10 and 16 across the euro area, whilst manufacturing declined closer to 30.

After the close last week, Italy was spared a potential downgrade to its credit rating by credit rating agency Standard & Poor’s. The rating was held at BBB which is seen as a bit of a reprieve for the country’s bonds. Forecasts have shown an increase in Italy’s debt level to 153% of gross domestic product (GDP) by the end of 2020 as the government battles to fight the economic impact of the coronavirus.

United States

A quieter week for US equity markets as investor focus was clearly watching any news on COVID-19. While a nuanced picture across different states remains, there were signs that new infections and deaths may be plateauing, and the picture in the US epicentre, New York, seemed to be easing. The debate around when and how to end lockdown was a key focus too, with the states of Colorado, Mississippi, Minnesota, Montana and Tennessee set to join several others in reopening some businesses. News that the US House of Representatives passed a US$484 billion package to aid small businesses and provide support for hospitals and virus testing helped support investor sentiment.

Looking at sectors, energy was the best-performing sector last week. In contrast, defensive stocks lagged, with the consumer staples and utilities both down on the week as we saw a little mean reversion for recent outperformers. Macro data remained weak, but broadly in line with market expectations: Weekly Initial Jobless Claims came in at 4.427million; March Durable Goods Orders were down -14.4%  and the latest Markit US Composite PMI stood at 27.4.

An interesting barometer of investor sentiment is the CNN Fear/Greed Index. It does still show a “Fear” rating; however, the latest reading is well off the “Extreme Fear” levels we saw back in March, pointing to an improvement of mood.

Asia Pacific (APAC)

It was a quieter week in Asia as well last week, with the MSCI Asia Pacific Index -2.3%. Chinese equities saw small losses. South Korea equities were lower, too, as GDP (quarter-over-quarter) was actually not quite as bad as feared. North Korea was in focus as there was much speculation around the health of North Korean leader, Kim Jong Un. Rumours circulated he was “gravely ill”.

While the COVID-19 pandemic appears under control in a number of APAC nations including China, New Zealand and Australia, there are concerns over rising case numbers in Japan. This will remain a key focus going forward.

Asian equities were well supported as we kick off the new trading week, with the Nikkei finishing up 2.7% after the Bank of Japan (BOJ) raised quantitative easing measures. Policymakers vowed to increase purchases of corporate bonds and commercial paper from a combined ¥7 trillion to ¥20 trillion; remove the ¥80 trillion annual quota for Japanese Government Bond (JGB) purchases; and start cash handouts as early as possible in May in what is the second straight month of expanding monetary stimulus from the BOJ. The central bank also kept rates unchanged, as expected.

Week Ahead

This week the European Central Bank will make its interest-rate announcement, and we will also see a plethora of first-quarter earnings reports. There is also a market holiday for some of Europe on 1 May.

Tuesday 28th April: 

  • Economic Data: France: (April) consumer confidence; US (March) wholesale inventories, (April) consumer confidence; Japan (March) jobless rate.
  • Monetary Policy: Riksbank interest-rate announcement: no change expected.

Wednesday 29th April:

  • Economic Data: Germany: (April preliminary) CPI; US (Q1) GDP; eurozone (March) money supply.
  • Monetary Policy: Federal Open Market Committee (FOMC) interest-rate announcement and Chair Jerome Powell press conference

Thursday 30th April:

  • Economic Data: France: (1Q, preliminary) GDP, (April preliminary) CPI; Italy (1Q, preliminary) GDP (April, Preliminary) CPI; Germany: (April) unemployment; eurozone (Q1) GDP; US (April) jobless claims; Japan (March) industrial production; China (April) manufacturing and non-manufacturing PMIs.
  • Monetary Policy: ECB policy meeting.
  • Holiday: Hong Kong

Friday 1st May:

  • Economic Data: UK: (March) M4 Money supply; US (April) ISM manufacturing; Japan (April) Tokyo CPI; OPEC+ supply cuts are scheduled to take effect.
  • Holidays: Germany, Italy, Spain, France among many other markets closed in Europe on 1 May for Labour Day. Hong Kong also closed.

     

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    This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 27 April 2020, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

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    MeDirect Disclaimers:

    This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

    The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

    If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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