Mike Pyle, Global Chief Investment Strategist, together with Elga Bartsch, Head of Macro Research, Scott Thiel, Chief Fixed Income Strategist, and Nicholas Fawcett, Member of Economic and Market 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.
The broad macro backdrop has been improving, risk assets have rallied a long way, and increasing market volatility points to risks that investors will need to navigate as the U.S. presidential election draws closer. All this leaves us moderately pro-risk as we head into year end, with a preference for credit.
Sources: BlackRock Investment Institute, with data from Haver Analytics, BLS, Eurostat, ONS, DARES, Spanish Labor Ministry, INPS, Autor et al (2020), September 2020. Notes: The latest estimates are for August in the U.S, July in the euro area and June in the UK. Official estimates of workers still covered by the U.S. PPP scheme are not publicly available, so we used the estimate published by Autor et al for June as the latest. Peak bars show the levels at the point where the take-up of furlough schemes was at its highest from March 2020. Euro area is based on an average of Germany, France, Italy and Spain.
We see localized restrictions – rather than a return to national lockdowns – as the main virus control approach over coming months. Fatality and hospitalization rates per infection have dropped even with higher case counts. Against this backdrop we use three signposts to assess the recovery: activity, policy support, and permanent scarring. The restart has so far surprised on the upside. This reaffirms our view that the cumulative shock from the virus should be a fraction of that from the global financial crisis, even though the harder part of the recovery lies ahead. Policy is still supportive of the restart, as illustrated in the chart by the fiscal support measures provided to key labor markets. Europe’s short-time work or furlough programs have supported a large proportion of the labor force, as the green bars show. The U.S. has focused on additional unemployment benefits. Both the UK and U.S. face risks stemming from an early end to such programs.
Monetary and fiscal policy have played a key supporting role for the private sector. U.S. jobs data have pointed to a further fall in the unemployment rate and an increase in labor participation. In Europe, labor market policies have kept a lid on the increase in unemployment. Yet they may delay the inevitable adjustment of some industries to a post-Covid world and weigh on productivity and wages in the long term. The key recent shift in monetary policies: The Federal Reserve has adopted an average inflation targeting framework and shifted to using “shortfalls” from full employment as key to assess labor market conditions. This raises the likelihood of higher medium-term inflation – and introduces other risks such as political challenges that may make it harder for the Fed to fight future inflation episodes.
So far we have seen limited evidence of permanent damage to the economy, even though many firms and individuals are going through a painful period of readjustment. U.S. bankruptcy filings for large firms rose sharply through July but have fallen in August. Some U.S. firms use bankruptcy proceedings to protect themselves from creditors while structuring for a post-Covid world. In Europe, bankruptcy data have been distorted by the temporary relaxation of requirement for unviable firms to cease trading. Euro area bank lending to non-financial firms is still growing strongly, providing companies with a lifeline. Yet we see risks that the policy support could produce unviable “zombie firms.”
The recent U.S. stock market selloff may be triggered by the unwinding of crowded positions in tech – this year’s best-performing sector. It also highlights some fundamental risks investors need to navigate in coming months, such as the increasing dominance of tech stocks in the market. Policy exhaustion is also a risk. A premature retrenchment could hamper the activity restart just as we get to the harder part of it. This might open the door to more considerable scarring of the real economy. The virus spread may pick up pace when the Northern Hemisphere enters colder seasons. The U.S. election in November also looms large, with the potential for drastically different implications on policy and markets.
The bottom line: We remain moderately pro-risk over the next six to 12 months. We prefer credit over equities tactically, as stocks have become more expensive relative to credit. In credit we favor high yield for its income potential and are neutral on investment grade. In equities we prefer the euro area market due to its cyclical exposure. We are underweight emerging markets outside Asia and neutral on EM Asia as the latter has fared better in both virus control and market performance.
Market Updates
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, September 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.
Market backdrop
Activity has started to normalize around the globe, albeit with renewed localized lockdowns to contain virus clusters. Market volatility is returning after months of steady advances in risk assets. Valuations have risen, and we could see greater volatility as a result, especially as the U.S. election closes in. A contributing factor: The outcome of negotiations of a new U.S. fiscal package appears increasingly binary: a sizable package or nothing at all before the election. In addition, the pandemic is still spreading in many countries, and U.S.-China tensions have escalated.
Week Ahead
- September 15th: German ZEW Indicator of Economic Sentiment; U.S. industrial production
- September 16th: Federal Open Market Committee meeting ends
- September 17th: Philly Fed manufacturing business outlook survey; policy meetings of Bank of England and Bank of Japan
- September 18th: University of Michigan Surveys of Consumers
Central banks will be in the limelight this week. The Fed, in particular, will be a focus as it conducts the first monetary policy meeting after unveiling its new average inflation targeting framework. Any details on what the framework means in practice could have significant implications for inflation expectations.
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