(Un)clear and Present Danger

Signs that the virus is peaking in the developed world.
Some signs have emerged over the weekend that the Covid-19 virus growth is slowing earlier than expected in NYC, the epicentre of Covid-19 in the US and EU. These numbers while still rising on an absolute basis, indicate that a potential peak could be seen in the coming weeks with death rates also not as dire as once predicted. The less bleak outlook has been met with talks of the US economy potentially opening in May, likely in phases. These changes are definitely a positive (as the market seems to be fully focused on new infections and not employment or the lack thereof) but of course as we are dealing with a biological matter which remains fluid, positivity surrounding the slowing rate of change could change, especially when vaccines are likely over a year out at best. For what it is worth, we should also be closely following China and Korean reinfections and developments in Japan, Indo, India and the lackadaisical (or calculated) Sweden. For now, a likely peak in infections by mid/end April could be on the cards for the developed world, a definitely positive as far as humanity is concerned.

Earnings season to cause the cooling of the Fed-induced rally?
If there is anything to derail the recent Fed induced rally in stock markets, it could be the event to watch out for this week that is the earnings season, which will likely unveil a slew of poor numbers and without much guidance. Using Chinese corporates as benchmark where corporate guidance has largely been absent highlighting the high level of uncertainty, the same could be likely for the US corporate and that is a bull case scenario in our view. The realistic one would likely be bearish, starting with the banks, JP Morgan and Wells Fargo who will be reporting tomorrow (It would also be interesting to see what Johnson and Johnson guides). Others to watch out for are US March retail sales figures from the Census Bureau on Wednesday which will likely exhibit the highest drop since GFC, initial jobless claim for the week ending April 11 on Thursday and the IMF reporting economic growth expectations on Tuesday (previously saw global growth at 3.3%, obviously this will be revised lower).

While the slew of bad news in earnings will likely be expected, the length of this slowdown and its destruction will be the key barometer to watch out for. For one, EPS expectations of the S&P which as at Feb 2020 was USD184 (by Factset) will likely be further downgraded from the current USD156 today to a level closer to the USD130-140 range implying a current trading PE ratio of over 20-22x, extremely expensive if juxtaposed against previous recessions where PE ratios have been at an average of 12x. Analysts will take this earnings season as an opportunity to cut target prices and earnings estimates across the board (some sectorial exceptions). At that juncture, it is not inconceivable for unemployment to play a more important role in determining market direction in the coming months.

No doubt the Fed’s extreme willingness to support markets to the extend of buying high yield junk bonds and the initial slowing of the pandemic at least to the developed world, are positives and have changed some learned opinions to not rule out that the lows have been reached, we are constantly re-evaluating this thesis to form some opinion on when risks look better contained. Central to that is monitoring the implementation and oversight of these monumental fiscal/fed subsidies/bailouts globally as they are rolled out over the course of the coming months and the ensuing impact to the economy.

Meanwhile, to assume the market trades up without absorbing the aforementioned fundamental hits would be extremely optimistic in our opinion especially given the end of the cyclical business credit cycle and uncertainties surrounding servicing of the bloated corporate (and unprofitable investments) and sovereign debt issuance. As such, while it is important to have some exposure to equities, we believe better entry points of going overweight on equities lay ahead in this fluid environment. For now the market will have to grapple with fundamentals rather than liquidity driven headlines by the Fed.

Oil- incrementally less negative but watch for near term supply.  
The recently concluded oil deal could be in focus this week where the curtailment short of 10 mil bbl (specifically, 9.7 m bbl/day 1st May-end June, 7.7 m bbl July – end 2020 and 5.8 mil bbl Jan 2021-April 2022) could be seen as a positive particularly when thinking about the bigger picture of an effective curtailment framework being put in place. Of course the effectiveness of the framework depends heavily on high compliance by the ‘makeshift cartel’ for the collective good, more importantly so in the current environment where demand appears moribund. This remains to be seen.

While there are reasons to be less negative, remember that curtailing supply is one, and demand another. For what it is worth, we do note that these cuts as expected, falls short of balancing markets (to put things into context, global oil production is c.100mil bbl/day as at April 2020 and consumption is currently at 85-90mil bbl/day and could be likely lower than this number should the virus lingers). As such to assume that oil trades up from current level would be optimistic in our view. While we are constructively ‘less negative’, it is worth nothing that the shortage of storage for oil produced coupled with the potential rise in near term output before the 1st of May start date could tilt oil prices lower in the interim. With the recent memory of global asset tailspin being sparked by the downturn in oil, we believe the expected volatility could cause further pain, giving good odds to the likelihood of higher corporate insolvencies emerging within the sector. This is of course negative, but equally, an opportunity for players with stronger balance sheets to consolidate for the longer term.