Macro Research
Economic momentum: Bottoming out as economies reopen
Preliminary purchasing managers’ indices (PMIs) show that economic momentum has bottomed out from record-low levels in May, after corona-containment measures were eased. Nevertheless, levels are still in contraction territory. Even if PMIs recover to expansion in the next months, it will take some quarters until growth is restored at pre-crisis levels.
On Thursday and Friday, ‘flash’ (preliminary) PMIs reported for select developed economies showed that economic momentum had bottomed out in May. This was broadly expected after the plunge to historical record lows in April, when the coronavirus containment measures (lockdowns, travel bans, etc.) hit economic growth most. Given first tentative easing of these measures in May in an increasing number of economies, less companies surveyed see further deterioration of economic conditions, resulting in a first step towards normalisation of economic activity this month. In particular the services sectors, which were most hit by the containment measures, snapped back significantly to levels around 30 for most economies.
Here the US sees stronger levels than elsewhere, which surprised markets as its later implementation of lockdowns had kept expectations at bay. Manufacturing, hit less by the measures, notes mostly around 40, only in Japan showing some further deterioration. However, the PMIs still remain in negative territory, as indicated by levels below 50. Since they are reliable indicators for growth rates, this means that headwinds for economic growth are indeed receding, but that the economies remain in contraction in May. Going forward, further improvements can be expected in the months to come. Even if PMIs float above 50 in the summer months and the global economy returns back to growth, it will take some quarters until gross domestic product (GDP) levels will be restored at pre-crisis levels.
David A. Meier, Economist, Julius Baer
Equities
Long-term bull remains intact
Equities look optically expensive but investors focusing on 12-month forward multiples may not capture the full upside. The average earnings growth 30 months after a recession trough since the end of World War II implies a S&P 500 forward P/E 2022 of 15x, which would mean another 15%-20% upside until the end of 2021. The risk continues to be to the upside. The S&P 500 is now up 32% since its March low, which puts the 12-month forward P/E of 22x at a hefty 30% premium to historical averages. However, those who focus on the next 12 months may be missing out on a large part of the imminent recovery. Based on consensus estimates for 2022, the S&P 500 is trading at a P/E ratio of just 15x, around 13% below historical averages, whilst markets tend to trade at a premium to historical averages during recovery periods. A forward FY 2022E P/E of 15x implies an earnings increase of 50% from the low point in Q2 this year until the end of 2022, which is what happened on average after every recession since the end of World War II.
The economic shock from the pandemic is bigger than ever but so is monetary and fiscal support. A second wave of infections may be likely but a second lockdown is not. Taiwan and South Korea were the most successful countries in combating the pandemic, both without a lockdown. Testing and digital tracing was more efficient and by far less costly than complete shutdowns. The Western world will be better prepared for a second wave than it was ahead for the first. This supports our case for a strong recovery without interruption. In the near term, equities have deserved a break after the recent run but the long-term bull case remains fully intact.
Patrik Lang, Head Equities & Global Equity Strategy, Julius Baer
Fixed Income
Turkey: Central Bank Delivers another rate cute
Turkey’s central bank has continued its easing cycle, cutting the policy rate by 50bps, in line with market consensus. In the event of pressure on Turkish assets, the central bank may have to reverse its cuts, despite President Erdogan applauding a single-digit policy rate in 2020, to help achieve an ambitious 5% GDP growth rate.
Turkey’s central bank has continued its easing trajectory, cutting the policy rate by 50bps to 8.25% on Thursday. According to the press release, the decision was based on coordinated expansionary measures by global central banks responding to the deteriorating growth outlook due to the coronavirus outbreak. The central bank acknowledges the weakening of economic activity due to the effects of the pandemic on tourism, domestic demand and external trade and will seek “to ensure the healthy functioning of financial markets, the credit channel and firms’ cash flows”. It also notes that high-frequency indicators for the first two weeks in May show signs of bottoming following the steps taken towards partial normalisation.
The current-account balance is expected to follow a moderate course until year end due to the effects of commodity prices and imports. This latest rate action has brought total rate cuts to 1575bps since June 2019. April’s inflation came in at 10.94% y/y and as such, real rates for Turkey are now at ca -270bps. At this meeting, the central bank considers inflation to be in line with its year-end projection of 7.4% y/y. President Erdogan’s target of 5% GDP growth for 2020, mainly through credit growth, remains unchanged, so the easing cycle is likely to continue.
Eirini Tsekeridou, Fixed Income Analyst, Julius Baer
Argentina: Deadline extended to Tuesday, 2 June
Argentina has extended the deadline for bondholders to respond to its restructuring offer to Tuesday, 2 June and will announce the results the next day. Argentina announced it will not pay the USD503m interest payment on its three bonds upon the expiry of the grace period on 22 May and is heading to its ninth default. Bondholders are unlikely to request the acceleration of their debt, as long as they expect that an agreement will be found. Argentina’s discussions with creditors continue as the creditor groups delivered counterproposals for restructuring the country’s ca USD65bn of foreign-law debt. According to media, bondholders seek to have the accrued interest paid, the grace period reduced as well as a security allowing them to participate in any economic upside, bringing recovery values closer to 55%-60%. Argentina has thus extended the deadline for bondholders to accept its current restructuring proposal to 2 June.
Furthermore, it announced that it will not pay the USD500m due on 22 May (initial payment was due on 22 April with a 30-day grace period), which will lead to the country’s ninth default. After that, bondholders will have the possibility to ask for the acceleration of their bonds, although as negotiations continue, bondholders are likely to refrain from such action, so long they expect an agreement to be found. An acceleration will require the consent of 25% of bondholders but it can be reversed within 60 days with a waiver from holders of 50% of the debt or if Argentina pays the overdue coupons. The continuation of discussions is a step in the right direction and we expect that both sides will ultimately soften their stance to reach an agreement in the coming weeks.
Eirini Tsekeridou, Fixed Income Analyst, Julius Baer
