Market anxiety eases from peak despite recession concerns

Financial systems, including markets, have seen the Covid-19-driven anxiety ease at varying degrees across asset classes over the last two weeks. Equity risk premiums hit a historical 30-year high around 20th March, before declining sharply by 45% in less than two weeks - faster than in any crisis event in the last 30 years.

We also add to our analysis the fact that the impact of Covid-19 on sovereign debt, credit/money markets and currencies has been much lesser compared to equities. Here too, there are signs of moderation in risk premiums. All this is despite the near certainty of a recessionary condition building up.

The orderly market condition can be attributed to aggressive fiscal (three times bigger than in the wake of Global Financial Crisis-GFC 2008 for G-10 countries) and monetary responses by the governments and central banks. Also, unlike GFC 2008, the financial systems were fairly resilient before the advent of Covid-19 crisis.

Importantly, US Federal Reserve’s total assets have expanded by US$ 1.6trn since mid-Feb’20, which is quicker than during GFC 2008. With this, the estimated money supply to GDP ratio (M2/GDP) may have risen to 78% (up 800bps), which is the fastest increase in any recessionary episode since 1980. This is positive for equities.

Based on previous research, we conclude that quantitative easing (QE) will initially attempt to alleviate financial market distress, but this purpose, along with fiscal stimulus, will eventually broaden to stimulate the real economy.

Update on Covid-19: The biggest positive is the increasing evidence of a flattening new-cases curve over the weeklong period – fresh cases lower by 19% and daily death rate dropped by 31%.

The decline in market risk premiums across asset classes is in-line with my expectation (Picking up from the pandemic stampede, 21st Mar’20). The positive incremental news on Covid-19 strengthens our case of a constructive backdrop for equity markets (Steeper decline in market risk premium constructive for equities, 2nd Apr'20).

Our stock selection is driven by bottom-up analysis of sustainable business, market leadership and value assessment.

Emerging evidence of global economic recession

Economic data releases point toward a steep contraction in output in the manufacturing and services sectors.

• The US non-farm payroll contracted by a massive 700k in Mar’20 after a robust +275k previously, which is expected to push up the unemployment rate to 7% in 2Q. US GDP is expected to contract by 7% in 2Q after an expected ~2% growth in 1Q 2020.
• Europe has also seen a steep decline in activities with the manufacturing sector PMI declining again to 45 in Mar’20 after recovering close to 50 in the previous month.
• However, the silver line is the rebound in China’s PMI to 50.1 in Mar’20 from 40.3 in the previous month. This mimics the significant decline in incremental cases of Covid-19 and the economy moving back to normalcy.
• In India, while the manufacturing PMI has declined from the sharp rise seen in Jan’20, it is still in the expansionary zone (>50). Also, RBI surveys of consumer and business confidence suggest improving activities in 4QFY20. Hence, we believe the full impact of Covid-19 will be visible in the Mar-Apr’20 indicators.