QUARTERLY GLOBAL OUTLOOK (Q1 2020)
Unprecedented shock, unprecedented impact
The first quarter of 2020 was an extremely weak period for markets, reflecting the economic shock of the COVID-19 pandemic spreading across the globe. Central banks and governments around the world reacted by loosening monetary policy and implementing aggressive emergency fiscal measures.
Even with the strong policy response, there is a significant risk that the reopening of the economy will not be smooth. There is a low degree of certainty about the kind and scope of economic activity that can resume without a new wave of infections. At minimum, investors should expect different sectors to recover their losses over different time frames as a return to any semblance of a “normal” business environment will not be uniform.
The pandemic-driven recession promises to heighten geopolitical risk, as countries seek to assertively control their supply chains. The oil crash resulting from the Saudi-Russian price war earlier this year also continues to weigh on energy exporting countries like Canada.
Against this complex backdrop, we continue to believe investors have to moderate their expectations and prepare for a period of lower and more volatile returns. Discipline, diversification, prudence around leverage and strong cost controls should be top of mind for investors.
COVID-19 casts long shadow over global markets in Q1
It’s difficult to overstate the impact of a pandemic that has caused more than half a million deaths, resulting in an economic catastrophe that led to unemployment increasing by the order of 10 times in just a few weeks.
Developed equities shed 21.7% (in local terms), while Canadian equities fell 20.9% as of March 31. Canadian benchmark 10-year government bond yields were down a full percentage point to 0.7%. Meanwhile, high-yield and investment grade credit spreads were wider from the start of the year, by 377 and 68 basis points, respectively. The CBOE Volatility Index (VIX), a measure of the level of fear and projected volatility in the market, stood at 53, indicating an exceptionally high level of investor uncertainty. Crude oil (WTI, near contract) was trading at US$20.50 versus US$61.10 at the beginning of the year, reflecting both the price war and the pandemic impact.
Long-term trends compound pandemic risk
COVID-19 is the single biggest risk facing investors as we began 2020. Geopolitical risk, the U.S.-China trade war and U.S. corporate earnings continue to be areas of concerns for investors.
In addition, we continue to believe a number of other long-term trends with challenging implications will continue to weigh on returns. First, secular economic headwinds could restrain real GDP growth and inflation, placing pressure on bond yields and earnings growth. Second, we have seen unprecedented stimulus and low real interest rates for more than a decade now, which will compound the impact of secular headwinds on risk premiums. Third, the high debt loads incurred by governments in the past decade – and most recently in emergency response to the pandemic – have weakened their ability to respond to future shocks. And fourth, there has been a compression of the illiquidity premium in private markets, highlighting the need for greater operational expertise to generate value, and suggesting that private investors’ skills will be tested in the future.
Investors should stay a disciplined course
Our view of what’s required to manage through this extremely difficult period has not changed from the start of the year. We believe investors should work to truly diversify their holdings to mitigate single-factor exposures and take a prudent approach to using leverage to mitigate risk and take advantage of in-market opportunities which could help improve expected returns. Active management strategies can also drive value in an environment like this one, although the other side of this coin is higher cost.
While many unknowns and risks currently cloud the outlook for the balance of 2020, we believe that the pandemic and its economic impact will continue to be felt throughout the rest of the year, particularly if reopening leads to a spike in reinfections, or if there is a second pandemic wave. This indicates a prolonged period of market volatility where challenges and opportunities alike will be plentiful and where discipline will matter more than ever.