Covid-19 restrictions are being lifted around much of the planet, and at rates that depend on when countries first suffered the pandemic. In Europe, glorious weather has buoyed households further as they emerge from lockdown. The Schengen free travel area within the EU has yet to be reopened, but once that is done Europe’s links with the rest of the world will follow. Airlines seem to be aiming for a resumption of regular services towards the end of June, which could both salvage something from the summer tourist season and reinvigorate corporate managers keen to resume business relationships. There is still plenty of uncertainty surrounding the disease, particularly the prospect of an effective vaccine. The markets will simply have to live with the risks implied with contradictory statements from scientists over the chances of a ‘second wave’.
Confidence over the end of the pandemic has enabled investors to look once again at the fundamentals. Avalanches of central bank liquidity have boosted asset prices again, including share prices for companies that continue to offer regular cash flows that will certainly revert to their former levels once the crisis is over. Mathematically speaking, an asset that generates perpetual cash flows in an environment of (effectively) zero interest rates has infinite worth… We would be winners today if S&P 500 profits were to revert to their 2019 level within 8 years!
Central banks will continue to print money for as long as their balances of payments remain close to zero. This is true for Europe and Japan, and while the USA is running an external deficit it is not calamitous and the dollar is the world’s reserve currency anyway. Venezuela can print all the currency it wants, but it still have to convert it to dollars to pay for imports – its exports do not cover its foreign currency requirements. Isolated within its Brexit logic, the UK could suffer a much weaker pound if it prints currency too freely. Japan shows that major economies can print a great deal of money without upsetting their short-term equilibrium. The dollar has weakened slightly, reflecting the fact that the Fed has printed far more money than than the ECB has: its balance sheet is up trillion, compared with a mere €800 billion in Europe. We believe that the US stimulus package is worth 20% of GDP; in France, national debt is set to rise from 98% to 115% of GDP as a result of higher spending and fewer receipts. More liquidity injections are on the way on both sides of the Atlantic, and there are hopes of a €750 billion EU stimulus package.
The market is not rebounding evenly. Healthcare and IT stocks are virtually back to their highs, but cyclicals such as travel and automotives are struggling badly. Energy and financials are in much the same position. The risks include mortgage REITs, which borrow massively from banks in order to lend it on to the real estate sector. Rising non-performance rates are keeping their share prices well down. Real estate does still offer opportunities, but there is no end of liquidity looking for a home.
World GDP could drop 3.2% this year, compared with a 1.5% drop in 2008. OECD countries will be the worst affected. In Asia, activity is weakening by less, and China is still looking at a 1.5% gain. Eurozone output is set to fall 6.6%, with France down 9%. The expected 4.7% rebound in 2021 assumes a resolution of the pandemic, of course. Some US macroeconomic indicators are up slightly, such as consumer confidence and the PMIs. But America’s big problem is unemployment, given the relative lack of a welfare safety net there.
According to the consensus, S&P 500 profits will be down 24% in 2020. At Chahine Capital, we are looking at 28%. A 17% rebound is expected in 2021. Our theoretical objective for this index is 2,903 points, down from 3,092 points last month because of the uptick in interest rates. Given our model’s extreme sensitivity to interest rates and the earnings CAGR, the drop in our objective does not worry us and we are maintaining our recommendation to overweight equities (an over 40% allocation, in our case).