Macro Markets update

In short

The below report is going to present the current Macro Markets update, which was prepared by Eurizon Asset Management.

Risk assets scored significant gains in the past month, making up in part the major losses incurred in the previous month. The recovery of risk assets materialized in an environment of easing volatility and was supported by a combination of good news on the containment of Coronavirus at the global level, and very determined economic policy actions aimed at containing the negative effects of the shutdown of the economies. Until lockdown conditions remain in place in the major economies, the combination of the slowdown of the contagion, and the economic policy responses, should allow investors to keep affording only secondary importance to economic data, that will increasingly outline a very sharp slowdown of the economy. However, starting from the second half of May, and in June, when social distancing measures will be eased, focus will shift to the effects of the resumption of activity.

A closer look

Risk assets scored significant gains in the past month, making up in part the major losses incurred in the previous month. Stock indices returned to levels roughly halfway between the highs hit in February and the lows marked in March. Spread bonds (Investment Grade, High Yield, Emerging markets) narrowed spreads, although the distance from the levels reached before the correction remains very substantial. US government bonds rates are close to their all-time lows (10-year rate in the 0.6% area), whereas German bond rates have been stabilising at around -0.4% for over a month. Spreads widened significantly on peripheral Eurozone government bonds, in waiting for more coordinated fiscal policy response at the European level.

The recovery of risk assets materialized in an environment of easing volatility and was supported by a combination of good news on the containment of Coronavirus at the global level, and very determined economic policy actions aimed at containing the negative effects of the shutdown of the economies. For what concerns the virus, evidence of a slowdown of the contagion in Italy since the end of March offered reassurances on the effectiveness of the social distancing measures adopted, fuelling positive expectations on containment in the other countries affected. More recently, further encouragement came from the fact that the contagion peak at the global level, and in the United States in particular, seems to become a couple of weeks before it was expected.

For what concerns economic policy measures, the US approach emerged as being the swiftest and most effective. The Fed, which had shown no hesitation in cutting rates to zero already in mid-March, then resumed QE, extending the range of assets eligible for purchase, to include Investment Grade bonds that, in the meantime, were at risk of being downgraded to High Yield status. A similar measure has been taken recently by the ECB, which will accept as collateral bonds subject to a rating downgrade to High Yield.

Fiscal Front

On the fiscal front, action was taken very swiftly and effectively in the United States, where Congress has already approved measures worth in excess of 2,000 billion dollars (12% of GDP). In the Eurozone, the Stability Pact has been suspended, allowing individual countries to put in place the necessary fiscal measures, straying from the budgetary frameworks approved by the EU Commission. As regards joint initiatives, the European Union has established a fund to protect jobs, enhanced the scope of action of the EBI, and offered unconditional credit lines for healthcare spending under the European Stability Mechanism (ESM): important actions, albeit not as fast and effective as taken in the US and, most importantly, lacking any major progress towards a more federalist approach that the issue of shared debt would have marked. The debate on this latter front is still open.

Until lockdown conditions remain in place in the major economies, the combination of the slowdown of the contagion, and the economic policy responses, should allow investors to keep affording only secondary importance to economic data, that will increasingly outline a very sharp slowdown of the economy.

However, starting from the second half of May, and in June, when social distancing measures will be eased, focus will shift to the effects of the resumption of activity. On this front, the spotlight will be on two main aspects. Firstly, the actual extent of the recovery of economic activity, that will depend heavily on which social distancing measures will have to stay in place. Secondly, the risk of the appearance of new contagion clusters following the easing of containment measures.

Market evolution

As regards the evolution of the markets, we note that even after the recovery scored in the past month, risk asset valuations still hold appeal, both in absolute terms, and in particular compared to the return offered by high-quality government bonds. US rates at 0.6% on the 10-year segment, and German Bond rates at -0.4%, are already pricing in ultra-conservative economic cycle scenarios. Investment Grade and High Yield bond spreads widened less than they did
during the 2008 crisis, which was a pure debt crisis (as is not the case today) and lacked the direct (Investment Grade) and indirect (High Yield) support provided by the central banks. Following the recent widening, these assets hold appeal. In a medium-term perspective, emerging country bonds also seem appealing, with spreads just below the highs hit in 2008,
although in this case no protection is offered by central banks (Fed and ECB), and low oil prices could keep volatility high on oil producer issues.

Peripheral Euro area

Peripheral Euro area bond spreads seem appealing, considering the ECB’s approach, which seems set on containing financial tensions. It should be said that the major issues of debt that countries will have to face in the next few months could hinder a swift tightening of spreads. Lastly, stocks: valuations in absolute terms (price-earnings ratio, P/E) have returned to levels in line with long-term averages on most indices but are showing a smaller discount than they were following the 2008 correction. However, the sharp decline of interest rates makes return from corporate earnings, while uncertain and on the decline in the current economic picture, appealing in a medium-long term perspective.

Investment themes

The favorable indications on the containment of the contagion and the size of the economic policy measures put in place at the global level, advise taking a moderately pro-cyclical approach, with a few exceptions.
The investment view for Eurizon portfolios is neutral on US duration, negative on German and quasi-core Euro area government bonds. Overweighting confirmed of non-core Euro area government bonds. Overweighting view taken on the spread markets; the stepping up of positions, initiated already in the course of April, is mostly concentrated on the components supported by central banks, therefore Investment Grade bonds and, secondly, High Yield bonds. Neutral view confirmed on equity. The near terms outlook still seems uncertain, and the market will unlikely build on the rebound seen over the past few weeks; in any case, a flexible management approach will be maintained, considering potential corrections with an eye to gradually stepping up positions.