COVID-19 Impact: AXA IM’s macroeconomic and investment strategy update – lifting the lockdown
The COVID-19 crisis continues to cause significant volatility. This is an exceptional and defining time for the global economy, but policymakers and central banks are taking decisive action to steady markets and the macroeconomic backdrop. Our investment experts outline their current views on the situation, explain what they expect could happen from here and highlight where there could be opportunity…
AXA Group Chief Economist, Gilles Moëc:
Most continental European countries have by now relaxed the conditions of their lockdown to some extent or are about to do so. We continue to expect a much better second half of 2020, but we are concerned by three forms of “backlash” which could impair the recovery.
Renewed tension in the Euro area, given the asymmetries, is the first one. The ruling by the German Constitutional Court (GCC) last week - which would force the Bundesbank to stop contributing to one of the quantitative easing (QE) programmes if the European Central Bank (ECB) fails to show its action is proportionate - is a significant hurdle. The central bank could technically “do without the Bundesbank” and still provide protection to the most fragile countries.
But fundamentally the legal conflict is about principles, and we fail to see how the ECB could submit itself to the GCC process without jeopardizing its independence and the unicity of monetary policy in the Euro area. True, it is high time anyway to relieve the ECB of its burden and solidify the monetary union with some form of fiscal mutualisation but the Eurogroup meeting last week did not make progress on the “Recovery Fund”.
Persistent weakness in emerging markets is the second form of “backlash”. Most of these countries have embarked on policy stimulus but their constraints are often much tighter than for the developed markets. Some of them are now also experimenting with QE – for instance the central bank of Brazil has been granted the permission to do so last week – but this comes with specific risks and limitations. The general lack of credibility of their policy-mix is contributing to the steep depreciation in their currencies. This can trigger financial stability risks via loans denominated in foreign currency (a key issue in Turkey).
The last item on our list is the resumption of tension between the US and China. The world could definitely do without commercial tensions emerging just when global trade may tentatively re-start, but it may be too electorally tempting for US President Donald Trump. China exited the lockdown earlier than the developed economies, but its economy remains subdued. So far it has refrained from embarking on “all out” stimulus. The perspective of more tension with the US may spur more fiscal and monetary action.
AXA IM Chief Investment Officer, Core Investments Chris Iggo:
There is an apparent disconnect between current equity market levels and the economic situation. Contractions in GDP, massive increases in unemployment and forecasts of record debt levels don’t sit well with a 20% to 30% rally in equity indices since 23 March.
Last week’s news was a case in point with the US reporting a 20 million decline in jobs and the stock market rallying 3.5% during the same week. This often leads to the conclusion that equities are over-valued and that investors should steer clear of stocks.
However, this is too simplistic. First, the economic news is not a surprise to anyone. It has been clear for a while that lockdowns would lead to a substantial loss of economic activity and employment. The equity market allocates capital on the basis of expected cash-flows in the future coming from company earnings. Thus, the current market levels are forward looking.
Whether they are right or not depends on the recovery. But even beyond that we can rationalise the disconnect. At the market level there have been losses. The S&P 500 has lost $2.5trn in market capitalisation since the beginning of the crisis. For this year we expect the US economy to shrink by around $900bn. That is quite a difference.
Secondly, the composition of the stock market and the broader economy is not the same. The sections of economic life most hit by social distancing are not the biggest sectors in the equity market. Last week’s US employment report showed the biggest job losses in April were in leisure, hospitality, education, health services and retail. These are not big weights in the stock market. They tend to be low wage, relatively low value-added service industries, not the leading generators of growth.
Third, the performance of sectors in the stock market reflects the economic picture. The worst performing sectors in the US have been department stores (mostly closed), airlines (no-one flying), hotels, energy related stocks and real estate trusts in the hotel and retail sectors. The best performers have been wireless services, internet retailers, food retailers, and internet-based home entertainment.
This should be no surprise to anyone that has been on lockdown for the last seven weeks. Related to this is the distribution of first quarter earnings. Sectors reporting positive earnings-per-share have been healthcare (bio-technology and pharma), consumer staples, IT and other consumer services. The losers were all the consumer discretionary industries, energy and financials - with banks diverting revenues to cover potential loan losses.
The point here is that the stock market is rational. Investors are allocating capital to those sectors least affected by the crisis and have the greatest potential to profit from the changes that are coming to consumer spending and business models. This supports active management. The AXA IM Framlington thematic equity strategies – one of which Jeremy will talk about – are well positioned, as active strategies can potentially benefit from these changes.
AXA IM’s Head of Investment Team, Framlington Equities, and manager of the AXA IM Global Technology and Digital Economy strategies, Jeremy Gleeson:
A core philosophy of our investment style is to identity good, quality companies. This means finding firms with good, quality management teams, who are addressing sizeable opportunities, with attractive medium-to-long-term growth prospects.
In addition to exposure to these long-term themes, our investments also tend to exhibit healthy balance sheets, often with net cash, high margins and strong cash flow generation.
The current global crisis is a perfect example of why we think investing in companies with strong long-term prospects is vital for the strategies we run.
Over the last few weeks, several of our holdings have reported their first quarter results, giving us some indication of how they have fared, so far, during this crisis - and what their views are on the outlook for their business.
For the most part, these results have been better than feared, suggesting that while there has been disruption as a result of coronavirus, it has not caused significant damage to their business models. Additionally, some of our investments have even delivered a positive inflection in growth.
For example, the benefits of e-commerce have come into their own over the last couple of months with companies like Amazon, and online grocery firm Ocado seeing a pick-up in business. Other beneficiaries of the increase demand for online commerce include fintech leader Paypal.
The need to work from home in recent times has supported demand for more cloud computing, cybersecurity and collaboration tools, and companies such as ServiceNow, TeamViewer and Atlassian have been amongst some of the beneficiaries of these needs.
We believe that the need for firms around the world to consider their role in the digital economy has become even more important. The demand for services that enable companies to engage with their customers through digital channels is already increasing. This has been demonstrated in the recent results for companies such as Five9, a provider of next generation customer contact centre technology and Twilio, a provider of a digital-communications platform that enables messaging via mobile apps.
We anticipate that as the pandemic crisis begins to alleviate and the global economy reopens, these companies will build on the strength that they have seen over the past few months to grow their business further.
AXA IM’s Head of Fixed Income Asset Allocation and Total Return, Nick Hayes:
Global bond market movements have been reasonably calm over the past few weeks. Markets have started to respond to the large central bank stimulus, and in turn investors have turned their attention to the timing and shape of the recovery.
Within our fixed income strategies, we have recently been looking to rotate out of some of our liquid cash and short-dated government bond positions and reinvest in higher yielding credit opportunities, as we believe valuations have reached more attractive levels.
This has included increasing our credit exposure in investment grade European bank debt, as well as attractive higher-quality new issues in sterling credit. The new issue market has witnessed enormous demand thanks to central bank support, which has given investors a lot of confidence. Here, we have been able to access debt from high quality companies at attractive spread levels.
Further down the credit spectrum, we have rotated out from some of our short-dated high yield positions into more aggressive higher-yielding credit on cheaper valuations.
In terms of sectors, energy and leisure have suffered, while technology and healthcare have enjoyed better performance. Overall, we continue to place a significant emphasis on more defensive areas such as core government bonds, inflation-linked bonds and cash, though we have increased our risk appetite since the end of March.
Given the unprecedented response from central banks, including quantitative easing and the purchasing of both government and corporate bonds, we think high-quality Treasuries can play an important role in the strategy.
That said, more yield and diversification can be achieved further down the credit curve. However, we also expect more volatility and will use our elevated cash levels and government bonds to purchase attractive credit as the crisis and recovery evolves.
When building a position, we monitor the market closely for good entry points and size it gradually in manageable steps, rather than trying to buy large amounts at a time.
As we work through the COVID-19 crisis and subsequent global economic shock and recovery, we will continue to place a great emphasis on maintaining a diversified pool of fixed income assets which aim to deliver attractive risk-adjusted returns.