“A throw of dice never will abolish chance” Stéphane Mallarmé (1897)
As major economies are trying to lift lockdown measures, investors are pondering the catalysts of the continuation of the recovery versus the reasons for renewed market weakness in this unknown territory.
Obviously, the bet of lifting the lockdown is motivated by the dire need to save the economy rather than by any solid confidence in the exit of the pandemic, as experts had recommended a longer lockdown. It is as if in the minds of our governments, the survival instinct now prevails over the precautionary principle. This means that we have to live with uncertainty, and this goes beyond epidemiologic probabilities.
Among the factors of uncertainty, the question of unemployment and the speed at which the US economy can recreate the 20 million jobs lost in April is crucial. In line with Blanchard/ Summers concept of hysteresis, some economies may take time to recreate those jobs, and could find a new equilibrium at a higher structural rate of unemployment, notably if sectors fail to bounce back rapidly such as recreation and leisure. Looking at corporates, the Q1 season was neither disappointing not reassuring, but a confirmation of our assumption of a 25 to 30% hit on full-year earnings, with a question mark that is shifting to the recovery pace.
Going forward, the policy mix will continue to be a driver of the confidence-recovery path. Should European countries agree on the proposed EUR 500 billion plan consisting in raising debt at the European Union level, this would be a strong catalyst for the euro and peripheral debt. The German Constitutional Court has created uncertainty around the European Central Bank (ECB), but we remain confident that the European institution will overcome this challenge, which is an opportunity to clarify simultaneously the mandate of the ECB and the supremacy of European courts over national jurisdictions. In history, the European Union has only been able to achieve significant progress by overcoming financial or political crises; so we could expect progress on this front, even if this is bumpy path with political road blocks and unexpected events on the way.
This sunny spring, one may wonder whether the old saying “sell in May and go away” will be valid this time around. Can traditional market seasonality patterns work in such a specific year? Beyond the unavoidable short term noise that will affect market direction, we find many fundamental reasons to remain constructive regarding financial markets on a medium-term perspective: people are returning to work, consumers are back, and earnings revision could stabilise and enable investors to focus on the 2021 recovery.
We are entering a new regime for investors, based on several paradoxes, with lower interest rates but more carry, with visible secular growth trends though more uncertainty surrounds capital returns. This should push investors to revisit the way they look at their portfolios and resist to rely too much on short-term emotions. Investors have to live and invest with uncertainty. Rationally, when interest rates are lower, the present value of visible future growth increases. This is the rationale of the quality-growth strategy. When uncertainty is high, the value of time increases and patience of long-term investors is well rewarded. This is carry strategy in a nutshell. Finally, any crisis is the catalyst of an acceleration of disruption of business models: this is the rationale of secular growth themes, which investors should focus their attention on.
Monthly House View, 22/05/2020 release - Excerpt of the Editorial
June 03, 2020