COVID-19 vs Past Crises, And How Has 5G Contributed So Far?

How does this crisis compare to previous ones?

The current crisis is essentially an event driven exogenous shock. Reactions during crisis period can usually be split into 3 segments: (1) market and economic impact, (2) policy response, and (3) deep discount in corporate earnings. Here, we compare the difference in monetary policy measures implemented thus far versus previous crises. The following are the responses so far in the current COVID-19 crisis:

(1) Market & Economic Impact – investors and companies rush for cash

We have seen global equities plunge 34% since the broader COVID-19 outbreak in February, compare to an average decline of 32% in bear markets with recessions since 1930s. Similar to 2008, gold saw significant decline initially as many investors needed cash to cover margin calls in other assets.

Emerging markets were hit particularly hard due to the USD funding stress, where we saw the Dollar Index surging more than 8.35% intra-month. In the credit space, investment grade and high yield credit spreads widened substantially, while US Treasury initially underwent a liquidity stress given massive deleveraged unwinding of systematic hedge fund strategies and massive outflows of bond funds.

There were only 5% of 140 recessions since 1980 that lasted no more than two quarters. Our base case scenario is there will be a significant fall in GDP in most regions in 2Q, followed by a progressive recovery in the second half of the year.

We have revised down sharply the average GDP growth forecasts for 2020 with the US at -0.7%, Eurozone at -4.3% and China at +2.6%.  

(2) Policy Response – avoid credit crunch, provide relief and stimulate economies

Monetary policy

Central banks globally have taken the “whatever it takes” approach to provide liquidity and ensure that markets continue to function. The Fed’s unlimited QE as well as the announcement to purchase Investment grade corporate bonds (first time in history) show their intent to provide as much support as the economy needs.

There has also been unprecedented moves beyond actions taken in 2008, such as the FIMA Repo Facility announced on 31st March which offers liquidity to foreign central banks in order to alleviate pressure on the dollar funding stress. 

Fiscal policy 

Governments globally have implemented sizeable stimulus packages. This includes China’s stimulus response of approximately 1.2% of GDP as well as a the historical USD 2 trillion relief package (10% of GDP) by the US Federal Government.

Elsewhere in Asia, countries are increasing stimulus size across the board. Singapore announced a second relief package, bringing its total package to around 11% of GDP. Malaysia likewise announced a economic stimulus package worth RM250 billion (17% of GDP) to combat the economic disruptions from lockdowns globally.

(3) Deep discount in corporate earnings - Market bottoms before EPS trough

On average in the last 3 US recessions (1990, 2001 and 2008), earnings were revised downwards by ~20%. The bear market tends to bottom 2-3 months before EPS trough.

2020 US earnings growth has been revised down from +9% at the start of the year to +3.6% currently. Further substantial discount in earnings growth by ~15% should be expected. Clearly the longer lockdowns around the world last, the more we should see earnings revised downward. 

Strong push for 5G infrastructure & application post COVID-19

As mentioned in the CIO Insights last month, technology is an area where we see massive benefits and potentially more investment capital post crisis. As more and more countries enter lockdowns, the usage of online platforms has increased.

There is also renewed interest in further development of humanless delivery, as well as industrial automation and smart logistics especially since the COVID-19 outbreak disrupted supply chains and manufacturing around the world massively.

Particularly interesting during this round of crisis is the application of 5G and artificial intelligence (AI) to combat the virus outbreak.

This was evident in China, where advanced digital capabilities like 5G networks and AI have been used in healthcare services, location-tracking processes, transportation systems and research facilities.

For example, patrol robots were actively deployed to aid containment. These robots integrate IoT, AI, cloud computing, and big data technologies to act as the first-line of defense, significantly reducing the risk of infection. Remote consultation and medical analysis between hospitals were also made possible through the 5G network, allowing focus on patients in critical conditions and helped improve the diagnosis and treatment process.

Post crisis, we believe there will be an increased push for 5G adoption. As countries globally move towards social distancing and lockdowns, work-from-home has become more of necessity rather than a choice. We saw an increase in demand on bandwidth, both for work-related applications as well as entertainment.

Seamless transition to ensure employees are capable of working from home is now a priority. There will be huge emphasis on things like 5G video conferencing, remote access, cloud-based application, as well as VR and AR to create alternative meeting places.

In fact, Chinese President Xi Jinping has already made a new push for 5G infrastructure in the country. 5G networks and data centres are now top priority on China’s plans to spend on ‘new infrastructure’.

The construction of the network is also expected to drive investment in applications in other industries, which is projected to exceed 3.5 trillion yuan in the next five years.

Conclusion

Due to the unpredictable nature of the current health crisis, we expect volatility to be high in markets, until a convincing containment of the virus is witnessed globally. In times like this, accumulation of risk assets such as 5G megatrend theme for medium to long term horizon looks attractive. 

KEY ECONOMIC VIEWS 

GROWTH

Covid-19 is an unprecedented shock to both supply and demand. The containment measures in many countries affect global value chains and push down labour supply. At the same time, households significantly retrench their expenditures in travel and recreational spending.

Fiscal and monetary authorities all over the world have been implementing the “whatever it takes” strategy, such as loan guarantees, liquidity injections, asset purchases and delays to tax payments etc in order to support the financial system and economies.

Our base case is that the Coronavirus measures will remain in place for a period of about 4-6 weeks before being relaxed gradually as the peak of the virus is observed. We expect a significant fall in GDP in most regions in 2Q, with a progressive recovery in 2H. We have revised down sharply average growth for 2020 with US at -0.7%, Eurozone at -4.3% and China at +2.6%.

INFLATION

We expect more slowing and possibly a temporary phase of deflation on a month-on-month basis. We see no reason to worry at this stage about a sharp rise in inflation over the coming years despite the renewed major fiscal and monetary policy stimulus measures.

Inflation accelerates as demand outpaces supply. This is not expected to be the case anytime soon.

EQUITIES

The amplitude of the fall in the current bear market (34%) is comparable to an average decline of 32% in bear markets with recessions since the 1930s.

There are 3 conditions that are needed for a sustainable recovery to take place:

(1) global rate of growth of coronavirus cases needs to decline,

(2) sensitivity of markets to bad news should weaken, and

(3) authorities need to convince that they will do “whatever is necessary”. We are well on that path but not totally there yet.

We downgraded financials to neutral and upgraded healthcare to positive from neutral and consumer staples to neutral from negative intra-month in March. In light of elevated market volatility in the short term, we favour the defensive sectors. The 5G and e-commerce themes also look interesting given change in consumer behaviour and business model during the outbreak. 

FIXED INCOME

Global markets witnessed deep selloffs as investors grappled with the idea of recession given the worsening spread of the coronavirus. Investment grade and high yield credit spreads widened substantially, while US Treasury underwent a liquidity stress given massive deleveraged unwinding of systematic hedge fund strategies and massive outflows of bond funds.

US Treasury bid-ask spread widened to alarming levels, before normalizing after a range of measures by the US Federal Reserve reassuring markets of their intent in preserving liquidity.

Part of the Fed’s measure to provide liquidity and improve funding included two facilities allowing corporate purchases on both the primary and the secondary market for the first time.

Given the relative cheapness of IG bonds, we therefore broaden our positive recommendation from quality issuers to all IG issuers. We also turn neutral from negative on US HY, after developments of possible agreement between Russia and Saudi Arabia which should then support oil price.

Asia and EM hard currency credit were hit particularly hard, thanks to the dollar funding stress as investors rushed towards USD liquidity out of fear of the economic impact from the COVID-19 outbreak globally. Countries with dual deficits, such as India and Indonesian, saw the worst performance, falling by 15.6% and 10.1% respectively.

FOREX

USD: The USD soared in March as worries about the economic fallout from the coronavirus boosted dollar demand globally. The risk off mode and the USD liquidity crisis pushed the USD higher against most currencies.

Globally, investors probably have a high exposure to the US dollar after several years of attractive relative yields, albeit the narrowing yield differentials should dampen its attractiveness going forward.

Additionally, the recently coordinated actions between the Fed and other central banks to preserve USD liquidity seem to have reassured markets and reduced the incentives to hoard US dollar.

JPY: The volatility of the Yen spiked in March and went back to levels reached in 2016. The safe haven currency has been vulnerable to the rush towards USD liquidity early this month.

However, the yen rallied last week of March alongside the rebound of stock markets, after investor’s panic subsided and the appetite for safe haven currency recovered. Large USD liquidity injected by central banks should avoid a massive USD hoarding, while the risk-off sentiment should linger over the weeks ahead and fuel appetite for the yen. 

ALTERNATIVES & COMMODITIES

COMMODITIES

Oil: Brent prices should rebound towards $45-55 in the second part of 2020 as supply declines in the US shale oil industry and as demand recovers when the lock-downs are slowly being lifted.

The price war between Saudi Arabia and Russia is too painful to last long. The probability of a new agreement to manage the supply is not negligible. This should accelerate the price recovery.

Gold: We remain positive on gold as its key fundamentals remain in place. With the new monetary stimuli decided by the central banks, real bond yields will remain negative or extremely low for longer.

Massive quantitative easing is also scaring some investors and reinforce the attractiveness of gold as a hedge. We still like to hold an exposure to gold in our portfolios as a hedge against tail risks, be they inflation, financial instability or geopolitical. We expect gold to trade in the $1535-1735/oz range in the coming months.

ALTERNATIVES

Long-Short Equities: We stay positive on long-short equities. Most managers have not actively de-grossed, except for market impact on longs (getting smaller) and taking profit on some shorts.

After a long period of expensive stocks, managers are using the crisis to up-grade their long portfolio into higher quality names. We still remain cautious on quantitative market neutral managers, liable to further deleveraging during the health crisis, and prefer fundamental managers without strong factor bias.

Global Macro: After Central Banks rolled out the most accommodative programmes and states enacted stimulative fiscal policies, core FX and fixed income markets are bound to react, and macro managers are best experienced to trade this.

Systematic trend followers (CTAs) have a structural role to play in a portfolio, as tail hedge in particular, should the Coronavirus crisis last and cause a severe recession. 

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