”Per Ardua Ad Astra” (“Through adversity to the stars”)
Royal Canadian Air Force Founding Motto
On May 30, the launch of the sleek SpaceX rocket with two NASA astronauts on board boosted America’s space program after nearly a decade of setbacks. More than 10 million viewers witnessed that historic lift-off against a backdrop of discouraging events on planet Earth.
Current economic numbers are certainly downbeat; however, the worst may be behind us. As economies around the world start to reopen following two and a half months of lockdown, we are transitioning into phase two of the pandemic crisis.
We are also in the midst of massive and widespread civil unrest sparked by the death of George Floyd, a black man who died in Minneapolis police custody. Business leaders across industries are expressing commitment to racial equality and acknowledging their companies must play a role in addressing or eliminating bias and inequities. These recent events have challenged all of us to take responsibility for tackling racial injustice.
U.S.–China tensions escalated after U.S. President Donald Trump was harshly critical of Beijing for a range of misdeeds, including mishandling the coronavirus outbreak. In a Rose Garden speech, Mr. Trump said, “The world is now suffering as a result of the malfeasance of the Chinese government.” He also announced that the U.S. would terminate its relationship with the World Health Organization.
In May, global stocks rallied for the second consecutive month despite weak economic data, armed clashes in the streets and bellicose rhetoric from the world’s two largest economies. Equities posted strong returns in North America, Europe and Japan. Hong Kong was one of the few major markets that saw negative equity returns in May.
After interest rates plunged in March, government bonds have generally traded within a tight range. Investment-grade and high-yield credit continued to trade higher, with interest rate spreads narrowing and bond prices appreciating in turn. With improving economic fundamentals and continued central bank support, the outlook for credit asset classes remains positive.
Commodity prices also benefitted from economic recovery hopes. Oil prices traded in unprecedented negative territory in April, then almost doubled in May. Copper – the bellwether industrial commodity – also rose 3% based on optimism that the construction industry is starting to rebound.
Canada – Rising star
We are starting to see the full impact of Canada’s extreme shutdown measures. March GDP numbers fell 7.2% from February, the largest monthly decline on record. First-quarter GDP fell by 8.2%, the largest drop since the 2008-2009 financial crisis. April data will probably be worse, but May’s numbers should be an improvement because businesses across the country began to reopen. Consumers remain cautious while Canadians increased their savings rate to 6.1% from pre-crisis levels of 3.6%. Businesses are seeing green shoots in key early indicators. For example, CN Rail’s volumes rose 4% thanks to increased automotive and lumber shipments.
Canadian stocks (measured by the S&P/TSX Composite) climbed almost 3% in May and are now up almost 40% from their March lows. Investors are optimistic that widespread reopenings will mean that April marked the low point. In terms of sector performance, information technology came out on top. Shopify, which helps businesses build their online commerce platforms, became Canada’s most valuable public company. The weakest sector was real estate amid mounting concerns that office and retail properties will be hard hit by a post-pandemic economy.
Bank of Canada (BoC) Governor Stephen Poloz told the Senate Finance Committee he is confident our central bank’s approach to a hobbled economy is working. The goal is to help Canadian households and businesses survive the financial fallout from COVID-19. The BoC is continuing its large-scale program of purchasing bonds to ensure liquidity in Canada’s financial system.
On June 3, the central bank held its key interest rate steady at 0.25%. It said, “While the outlook for the second half of 2020 and beyond remains clouded, the Bank expects the economy to resume growth in the third quarter.” June 3 was also the day that Governor Poloz passed the reins to his successor, Tiff Macklem. Interest rates are expected to remain at low levels for the remainder of this year, as inflation is unlikely to pose a near-term risk.
The loonie has appreciated versus the greenback thanks to demand for riskier assets and improving oil prices. It should stay at current levels as long as these two conditions persist.
United States – Moonshot
The U.S. is now fighting a global pandemic and an economic downturn while dealing with nationwide unrest stirred up by racial injustice. Some governors called in the National Guard to restore order after protests erupted in major cities. Local governments also set curfews just when businesses were hoping to reopen from COVID-19 lockdowns.
Since March, the U.S. has lost more than 40 million jobs. It’s not surprising that U.S. shoppers cut their spending in April by a record-breaking 13.6% compared with March, and boosted their savings to a record high. Consumer spending accounts for more than two thirds of U.S. economic activity, making it an important metric to watch.
Economic activity in the U.S. dropped by 5% in Q1, the largest quarterly rate of decline since the 2009 recession. Q2 is expected to be worse, even though economies are starting to reopen. Profits also fell in Q1, dropping 14% compared with last year.
When Twitter added a fact-checking warning to some of President Trump’s misleading tweets, he sought to retaliate against social media firms that have been so pivotal to his platform. The President signed an executive order designed to limit legal protections for online platforms.
Information technology continues to lead strong returns for the S&P 500, which rose 6.8% in May. The technology-heavy Nasdaq Composite rose 6.8% and is now within striking distance of its all-time high (reached in February). Markets continue to reward technology companies – such as Microsoft, Netflix and Amazon – that are less reliant on predicting economic recovery.
Europe and the U.K. – Failure to launch
In step with the rest of the world, the eurozone economy will also suffer a profound recession due to the coronavirus pandemic. The European Central Bank (ECB) expects that 2020 will bring an 8.7% contraction that falls somewhere between the bank’s medium and severe scenarios. On June 4, ECB President Christine Lagarde announced the bank will increase its asset purchase program amid the steepest slowdown in the region since World War II.
The European Union and the U.K. continued strained video negotiations on their complex Brexit trade deal. Both sides reported minimal progress despite the looming year-end deadline to which British Prime Minister Boris Johnson remains committed. One key stumbling block is whether it makes more sense to strike several mini deals instead of one big agreement.
European equities rose almost 5% (measured by the Euro Stoxx 50 Index), fuelled by strength in German stocks. Germany opted to keep most of its factories open during the lockdown and thus suffered less economic devastation than other eurozone countries.
Japan – Over the moon
Buoyed by broad-based stimulus measures that exceeded expectations, Japanese equities were global top performers in May as the Nikkei rewarded investors with an 8% return. This strength came despite Japan’s Q1 descent into a recession (defined as two consecutive quarters of negative GDP growth). The Japanese economy contracted at an annualized pace of 3.4% in Q1, following a plunge of 7.3% in Q4 of 2019.
To combat the pandemic downturn, Prime Minister Shinzo Abe approved a US$1.1 trillion stimulus package. This package doubles the amount committed in April, bringing stimulus relief to US$2.2 trillion, or approximately 40% of Japan’s output. Mr. Abe also lifted the national state of emergency in place only since April.
China – Back to earth
Chinese equities did not participate in the global rally, as the Shanghai Composite traded relatively flat in May. Recent economic data showed modest improvement, but not the V-shaped recovery that many were hoping to see. China’s economy was the first to emerge from coronavirus lockdowns in April, so the world is closely monitoring its economic recovery pattern. Beijing is worried that the recession will last longer than anticipated. Demand for Chinese exports remains below pre-coronavirus levels since large economies around the globe are only now emerging from lockdown. For the first time, China’s leadership decided not to set an economic growth target, given the state of uncertainty.
Further erosion of relations with the U.S. is adding turmoil for the world’s second largest economy. In May, President Trump threatened to “cut off the whole relationship” due to China’s failure to contain COVID-19 and its crackdown on Hong Kong. To further punish China, Mr. Trump then ordered his administration to begin the process of eliminating special U.S. treatment for Hong Kong. This means that the U.S. would revoke the territory’s privileged trade status and treat Hong Kong as it treats the rest of China. Investors are now concerned that last year’s U.S.-China trade pact could be in jeopardy.
Hong Kong equities reacted negatively to Beijing’s new national security legislation that would erode Hong Kong’s autonomy. They traded down 7% last month when most global stock markets rose handily.
Our strategy
According to research house Cornerstone Macro, global monetary and fiscal policy measures are now estimated to account for 27% of global GDP. This level of stimulus has helped to catapult equity markets significantly higher. At the same time, yields on low-risk, fixed-income asset classes are at historical lows, making the trade-off between equities and bonds difficult to calibrate.
Our base case assumes that economies worldwide will successfully restart the twin economic engines of businesses and consumers. They will reopen at various times depending on their COVID-19 situations and it will take longer for some economies to recover. Manufacturing and industrial sectors will also contribute to the COVID-19 recovery story. We continue to believe that resilience of the U.S. consumer and technologyheavy growth sectors will keep U.S. equities in a leadership position for now. Nonetheless, Trump administration policy decisions could shift this outcome.
The primary risk to our base case is a potential COVID-19 resurgence once physical distancing measures are relaxed. A second, damaging lockdown would likely follow. Investors will also weigh continued signs of economic improvement and stimulus against simmering trade tensions.
The last word
As we transition to phase two – the recovery phase – of this pandemic, many questions remain. How fast can our economies rebound? How big will a second wave of coronavirus be? How much more government stimulus will be forthcoming? The reopening of economies will mean that the recession phase of this downturn will be brief. Yet, that doesn’t preclude a long road to recovery that will likely be uneven and sometimes unpredictable.
On May 30, NASA’s stirring phrase “we have liftoff” once again set hearts racing. It was a welcome distraction from problems currently troubling our home planet. Astronaut Bob Behnken said: “You see that it’s a single planet with a shared atmosphere. It’s our shared place in this universe. So, I think that perspective, as we go through things like the pandemic or we see the challenges across our nation or across the world, we recognize that we all face them together.”
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