Some legitimate worries, but priority goes to the recovery theme - Dorval's Macro Corner (May 2020)

"Adapting economic knowledge to market realities and breaking free from the tyranny of indices"
François-Xavier Chauchat
Member of the Investment Committee. Macroeconomic framework and asset allocation.
As the severe confinement ends, questions arise about the political, fiscal, social, economic and financial consequences of the coronavirus crisis. Tensions are already rising again between the United States and China, and the German Constitutional Court has just issued a destabilizing ultimatum to the ECB, giving it three months to justify some aspects of its public debt purchase program.

In the short term, however, governments, businesses and investors will remain focused on the dynamics of reopening economies, and on deepening the already massive fiscal and monetary support measures. In this regard, we note that the German government is seeking to minimize the impact of the Karlsruhe Court’s judgment, leaving the ECB to continue its action.
 
The risks are the least controllable on the virus side, but here too the recent news is quite encouraging. At this stage, none of the countries that have already reopened their economies (China, Austria, Korea, etc.) have faced a second major wave of new cases. This is obviously the crucial point because the faster and more complete the reopening of the economy will be, the less the damage caused by the crisis will last. As in China, the slump in the tourism, recreation and transportation sectors, as well as the precautionary measures still in place, weigh heavily - but this is likely to change as well. Several treatment protocols could also be validated in the coming weeks. In addition, the release of fiscal arsenals militates for a constructive vision, with more recovery plans to come. Finally, despite the explosion in technical unemployment, most of the incomes have been preserved thanks to governments intervention, which allows for a rapid recovery in demand. In developed countries, a return to the level of 2019 GDP is therefore possible in the second half of 2021. This is not a particularly optimistic scenario, since this level would still remain more than 3% lower than forecast before the crisis. The recovery should therefore have to continue in 2022 and 2023.
 
After the strong stock market rebound in April, many voices are raised to worry about supposed complacency by investors. This is not our analysis. We do not see a disturbing disconnect between stock prices and the foreseeable trajectory of global GDP. Above all, the collapse of banking, cyclical and commodities stocks does not fit well with fears of market complacency. Nor are we seeing optimism in risk appetite measures, but rather a partial easing of the solvency and liquidity risk premiums that piled up in March.
 
Unlike 2007/08, which had seen a complete reversal of market leadership, the shock of the coronavirus has above all accelerated trends already in place. Nearly zero interest rates on public debt have spread to almost everywhere in the developed world, the theme of the digital economy is triumphing, and investors favor companies with solid balance sheets. As a result, the valuation of the Nasdaq and growth stocks has soared, and the sectors that were already the cheapest before the shock are even cheaper. For us, these divergences call for a rebalancing of the portfolios towards the assets most likely to benefit from the reopening of the economies, including the cyclical sectors and the small stocks. Dorval AM's portfolios are well positioned to benefit from this recovery, although we will remain reactive in the face of the many unknowns of this health crisis.

 

Download Dorval’s Macro Corner of May 2020 in PDF version here

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