Introduction and review of our prior outlook
Very few could have foreseen how deeply this crisis would descend. We certainly did not. Financial panics often occur “out of the blue”, and the fact that US credit and equity markets were “priced for perfection” and heavily leveraged made the tumble much worse. The recent massive involvement of the US Treasury and Federal Reserve (Fed) throughout private credit markets takes markets into uncharted territory, although the European Central Bank (ECB) and the Bank of Japan (BOJ) have, in smaller scale, long led the way in several aspects. The near-infinite expansion of sovereign bond QE also is an incomparable shock to the system, almost like setting to maximum the electricity used to stimulate the brain of a comatose patient. Better to have the patient alive, but the consequences and subsequent treatments are unknown. On the positive side, it is important to remember that China’s economy, which is key to the global production supply chain and a major engine for global demand, is on the mend.
We have long thought that the odds were very high that the novel coronavirus would dissipate in a reasonably expeditious manner, for which we now target a mid to late April peak in the developed world. Unfortunately, the damage done, including to political and social systems, in order to achieve such, and the ability to recover from it, is what we needed to address in this meeting. There are no proper parallels in history and nothing will ever be quite the same, so it will take mental flexibility and knowledge of human nature and politics to steer a proper investment course. We don’t claim super-human status, but our Global Investment Committee members have immense amounts of experience as leaders of our equity, fixed income and multi-asset teams around the world, so we hope to provide as solid advice as humanly possible.
The global economy’s 1H plunge should disappoint consensus and 2H rebound should be moderate
In our new outlook, due to all the uncertainty, we concentrate on the economy and markets only through September, rather than the usual next twelve months. Although we look for a recovery after June, the G-3 and Chinese economies should plunge, moderately below consensus (which is very hard to discern right now, changing daily but with some estimates still very stale, so we made our own assumptions for such) in the 1H, and also slightly disappoint in the 2H, at least in the US. The 2H recovery should be moderate, with a disinflationary tenor. For the U.S., GDP should be -7.8% half on half seasonally adjusted unannualised rate (HoH SAAR, as used in all references below) in the 1H20 and 2.2% in the 2H20, vs. the -5.0% and +3.0% consensus estimates. In the 1H, personal consumption and private capex should sink, but government spending and net foreign trade should contribute to growth. Boeing’s aircraft production problems will exacerbate the growth problem. In the 2H, personal consumption should improve and government spending will remain strong, but capex is likely to remain weak and net foreign trade should stop contributing to growth.
Eurozone GDP should be very similar, at -8.2% and 2.4%, vs. consensus estimates of -5% and 2.2%, respectively, while Japan’s will likely be -6.2% and 3.0%, vs. consensus estimates of -4.2% and 2.0%. Japan’s 1HCY19 figure is better than the others as its 4QCY19 base was already weak due to the VAT hike and natural disasters then. For the Eurozone and Japan, personal consumption, private capex and government spending should follow the US experience, but net foreign trade’s contribution will have various trends. For CY20, growth for the US, Eurozone and Japan should be -2.9%, -3.1% and -2.7%, respectively (vs. consensus of -1.3%, -1.4% and -1.9%). Lastly, China’s official GDP should be -12.2% HoH SAAR in the 1H and +8.3% in the 2H, with CY20 GDP at -2.7%. Its 1H is worse than the G-3 because its crisis started early in the period, and due to this lower 1H base, its 2H rebound will be stronger than the G-3. Of course, the fact that its economy is already recovering is a major boost to the globe’s prospects. Overall, these G-4 1H GDP results should disappoint risk markets and keep fixed income markets relatively encouraged, but the 2H should not disappoint too much.
Non- economic factors remain a concern
There remain good reasons for concern about many geopolitical issues, especially regarding China and the Middle East. In times of crisis, leaders often turn to nationalism, and some countries may feel the West is pre-occupied with economic issues and will not respond to aggression. Although partially on a temporary truce, relations between the West and China remains fraught with danger. Meanwhile, the Middle East is even more a powder keg than usual, with Iran becoming increasingly desperate and Turkey involved in a strange form of proxy war in Syria vs. Russia.
As if this was not enough to worry about, the economic impact of the virus crisis will greatly influence the US election. Although the public reaction to US President Donald Trump’s performance during the crisis is mixed, as it has been during his entire tenure, there is a 50% chance that he will lose the election. Much depends on whether Joe Biden can perform as a viable Democratic candidate or if he is somehow replaced at the last minute by a different moderate candidate. The Congressional 2020 elections also are a source of great uncertainty for markets and if there is a Democratic sweep, then anti-business reforms will surge. Even if Congress is split, as is our prediction, any Democratic president would need to satisfy a very angry left wing via important cabinet positions and hyper-active executive actions and regulatory mandates. In such a case, the only thing a split Congress could prevent is major tax increases, so the net result of potential political change should make risk markets wary of getting too optimistic.
Central banks: All-in
The Fed’s massive involvement into private credit markets and the global near-infinite surge in QE for sovereign bonds leaves markets in unchartered territory. Perhaps the question now is what will central banks not do? There remain questions as to how the one segment that is not fully addressed by central banks so far, high yield bond and credit markets, will survive, especially in the US with its oil sector’s great reliance on such. The US shadow banking system also has a large reliance on risky credit markets. The economic ramifications of trouble from high risk credit markets should be large for the US, but much less so for Europe and Japan. China has a huge shadow banking system and its largest property companies have high leverage ratios and borrow in immense size, including in foreign currencies. Some of this will be solved through government actions, but not likely without significant pain to some of them and their creditors. In sum, however, globally, central banks are fully committed and it is not impossible that the ECB and Fed could buy equities and high-yield bonds if economies and risk markets worsen even further.
Slightly weaker USD and moderately rising G-3 bond yields
We expect US and Eurozone bond yields to rise, but not by much because they are pinned down by low central bank policy rates and in most cases, continued QE. Also, the global economic recovery will disappoint consensus in the 1H, in our view. For US 10-year Treasuries, our target for end-June is 0.95%, while those for German Bunds and 10-year JGBs are -0.20% and 0.0%, respectively. For September, we expect 1.05%, -0.10% and 0.00%. Regarding forex, we expect the yen and euro at 110 and 1.08 vs. the US dollar, respectively, at end-June and 109 and 1.09 at end-September. This appears like too little volatility for forex markets, but such is the trend in recent quarters and each region seems to be reasonably content around current levels.
This all implies (coupled with our forex targets) that including coupon income, the FTSE WGBI (index of global bonds) should produce a flat unannualised return from our new base date of March 20th through June in USD terms, and -0.2% through September. Thus, at this stage, we have an unenthusiastic stance on global bonds for USD-based investors. For yen-based investors, this index in yen terms should return -0.7%, and -1.8% for those periods, with JGBs returning +0.8% for both periods.
As a side note, our Brent oil price forecasts are essentially flat at USD 27 through September.
Global equities likely rebound a bit further
As mentioned earlier, there remain many global macro-economic, US election and geopolitical problems to sort out, so our new scenario is not overly bullish on global equities. Aggregating our national forecasts from our base date, we forecast that the MSCI World Total Return Index in USD terms will be 11.7% through June and +18.0% through September (+10.9% and +16.0% in yen terms, respectively). This suggests a positive stance for both USD-termed and yen-based intermediate term investors. Although we are positive for this period, our forecasts entail only about a half of what was recently lost being regained and we do not envision record highs for quite a while.
In the US, the SPX’s PER on CY19 EPS is now about 15, which is far from a major bargain even given the prevailing low interest rates. Furthermore, dividends are likely to be cut sharply in order for indebted companies to preserve their investment-grade rating (and even more so for high yield companies), so the dividend yield is quite uncertain now and probably near zero for number of formerly high yielding sectors. CY20 EPS is likely to be considered irrelevant and more weight given to CY21 EPS growth due to the improved global outlook by then. Buybacks will also greatly diminish, especially in some sectors, but enough will remain to provide at least some support to the market, so we expect the SPX to rise to 2,578 (+12.6% total unannualised return from our base date) at end-June, and to 2,729 at end-September (+19.8% return), with yen-based returns being +11.8% and 17.9%, respectively.
European equities should rebound too, although at a much slower pace due to lower confidence in the intermediate term economic future. The PER on CY19 EPS has fallen back towards the low end of recent historical norms, at 13.5, but here too, dividends are likely to be cut sharply and while CY20 earnings will likely be terrible, CY21 estimates are likely to rise significantly. The region’s absurdly low interest rates will help equities to some degree, as will the 2H global economic rebound, so we expect the Euro Stoxx index should rise to 290 at end-June, and FTSE to 5,300, which translates to returns of 5.9% (unannualised from our base date) for the MSCI Europe through June in USD terms (5.2% in Yen terms). Returns through September should be even better, at +10.1% (and 8.3% in Yen terms) in our view, with the EuroStoxx and FTSE at 295 and 5,400, respectively.
Japanese equities severely underperformed global markets for the last year through 20 February, but have recaptured it all in the past few weeks. Japan, though hit by the VAT increase and the globe’s problems (especially China’s), did not have to shut down its economy as the virus did not surge into major hardship. Also, the BOJ was supporting equities, valuations were already low and leverage/credit excesses were very minor. Although CY20 earnings should be poor, CY21’s prospects should rebound on the improved global outlook. Valuations are very reasonable, with TOPIX at 12.2 times CY19 EPS consensus earnings and dividends are less likely to be cut much for the overall market. Improvements in the global semiconductor and smartphone cycles (which previously hit Japanese semiconductor product equipment, electronic components and supplies very badly) and better Chinese demand for capex goods, especially for 5G infrastructure stimulus, should boost earnings and thus incentivize investors, especially foreigners, to return to Japanese equities. Thus, we expect TOPIX to hit 1,453 at end-June and 1,481 at end-September, for total unannualised returns of +15.0% through June in USD terms (14.1% in yen terms) and 19.0% (17.1% in yen terms), respectively, from our base date. Our targets for the Nikkei are 19,900 and 20,300, respectively. These are higher returns than in the US or Europe, so Japan should be overweighted by global investors, and these projected returns should be extremely attractive for domestic investors.
Developed Pacific-ex Japan MSCI: the improvement in China’s economy should clearly help this region, although Hong Kong’s political challenges remain a headwind. At least in the short-term, we are positive on both the Hong Kong and Australian markets, with the Hang Seng at 25,881 and 27,057 at end-June and end-September, respectively, and the ASX at 5,298 and 5,075, respectively. In sum, we expect the region’s MSCI index in USD terms to rise 13.1% through June and 14.9% through September (+12.3% and +13.1% in yen terms), so this region should also be at least neutrally weighted.
Investment strategy concluding view
Two major sentences stand out from our December summary: “global prospects almost look ‘too good to be true’” and “it doesn’t seem possible that everything could be as positive as we forecast, and certainly there will be some unexpected events and volatility, but in the end, the solid upward equity market trends seem very hard to disrupt and G-4 governments and central banks seem happy to ride the wave.” Little did we know how this scourge could disrupt the world. On the positive side, we expect the virus to peak in the developed world in mid to late April and it is important to remember that China’s economy, which is key to the global production supply chain and a major engine for global demand, is on the mend. Although economic growth will not surprise on the upside, in our view, it will certainly return in the 2H, accompanied by massive government and central bank stimulus. Thus, although such will retrace only about a half of what was recently lost, we expect very good USD-termed gains in all major global equity markets through September and suggest that medium to long-term global investors should overweight global equities vs. global bonds.
© Nikko Asset Management
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