OCBC OneWealth App– In the ashes of adversity, lies opportunity

Economics

Equities

Asia Ex-Japan

Outlook

Covid-19 global pandemic

In the ashes of adversity, lies opportunity

14 April 2020

Unprecedented crisis

The global Covid-19 pandemic has triggered many firsts. For one, the speed of market decline was unprecedented. It took all of 23 days for the S&P 500 index to fall more than 30% from its peak, the swiftest decline on record. It took all of 13 days for the index to rise more than 20% from the bottom, by definition, entering a bull market (Chart 1).

Expectations are for the global economy to contract the most in the second quarter since the Great Depression, as governments shut down their economies in a bid to contain the spread of an awfully contagious virus. Containment efforts have already come at great economic costs. For instance, more than 16 million Americans have applied for unemployment benefits over the past three weeks alone, a number set for the record books.

The economic challenges wrought by the Covid-19 outbreak has also led to the largest economic intervention in recent history. From an alphabet soup of lending programmes by central banks to trillions of dollars’ worth expansionary fiscal packages, governments around the world are resolute in their commitment to backstop the pernicious economic fallout from the sharp decline in economic activity.

In one fell swoop, a virus outbreak has led to unprecedented market declines, unprecedented economic contraction and unprecedented government support. Indeed, we are living in unprecedented times. But even in unprecedented times, opportunities abound.

Managing the risks

The precipitous decline in global stock markets have investors questioning if it is an opportune time to load up on risk assets again. Judging by the recent rally in the US stock market (Chart 1), one would think the worst might be over. But the inconvenient truth is that a great deal of uncertainty still looms large over important questions including: (1) Have we reached the peak in infections globally; (2) Are government efforts truly sufficient in mitigating the real impact of the virus and economic shut down and (3) Is there a meaningful risk of a resurgence in infections that might force future shut downs.

Answers to these questions are mostly educated guesses at best. Amid unprecedented times and heightened uncertainty, history is our only guide. What’s clear is that resolutions to these types of market crises tend to be protracted affairs. Even after the easing of initial spikes in volatility, there might be subsequent market aftershocks, as second-order effects from the initial sharp impact works through the economy.

Yet, uncertainty works on both ends. There are upside risks to consider as well. This is especially pertinent if the pandemic sees a sudden resolution through the discovery of a vaccine or if developments continue to point to meaningful declines in infection rates and portend some stability in the current health crisis. Given the unprecedented scale of monetary and fiscal policy support, the likelihood that asset prices will recover sharply after the Covid-19 crisis abates is fairly significant. This is something we should remain cognisant of as we determine the path ahead.

Stick to quality, phase in investments

Attractive equity market valuations provide a good reason to start accumulating stocks. However, the uncertain and volatile market terrain argues for selectivity in stock-picking and underscores the need for a long-term perspective. After all, not all stocks that have been beaten down are cheap.

To do well over the long term, a company has to first survive the challenging macro-economic environment over the short term. Some companies, particularly those with weak balance sheets and at-risk business models, may see their intrinsic valuations permanently impacted by the Covid-19 crisis, and some might not even survive the rocky environment ahead.

Companies with strong balance sheets and resilient business models may face near-term pressure on their cash flow and earnings as a result of the Covid-19 crisis but should be able to weather the storm and emerge stronger in the long-run. Hence, declines in the prices of these quality stocks in the near-term may improve the risk-reward over a longer time horizon.

The volatile market environment also calls for a phased approach in terms of market entry. Timing the market bottom is a fools’ errand in a period where news headlines can easily elicit sharp and sustained moves. A better approach would be to phase in one’s investment, for example accumulating stocks in five different tranches rather than going all-in at once.

Making the case for Asia ex-Japan

In terms of regional preferences, we believe long-term fundamental value has emerged in Asia ex-Japan stock markets, particularly in Singapore, Hong Kong and China.

From a forward price-to-earnings perspective, these three markets are trading below their long-term averages (Chart 3). In particular, Singapore stocks, as proxied by the MSCI Singapore index, look heavily discounted relative to its peers and are trading at very attractive valuations.

Importantly, these economies are also at the forefront of controlling Covid-19 infection rates relative to the US and Europe, having been affected by the epidemic early on and having taken swift and significant steps to curtail its spread.

Focussing on China, draconian measures to contain the virus have proven successful in driving down new cases (Chart 4). Reopening its economy has been a rocky process, but activity indicators are showing encouraging resumption of economic activity. For instance, China’s manufacturing purchasing managers’ index (PMI) rebounded to 52 in March from an all-time low of 35.7 in February, showing a stronger than expected recovery in manufacturing activity (Chart 5).

Policy makers in these markets have also swiftly introduced record stimulus measures to counterbalance the economic pain of containing the Covid-19 outbreak. Singapore’s government, for one, introduced three different fiscal packages – Unity, Resilience and Solidarity – worth a record $$59.9 billion, or 12% of GDP, to help tide over the one month circuit breaker period from 7 April to 4 May, in an effort to contain the spread of the virus. The circuit breaker period has seen the closure of all schools and most workplaces aside from essential services.

Much of the outlook in Asia also depends on the stability of US financial markets and US Dollar funding conditions. Tight US Dollar liquidity conditions have eased somewhat, as can be gleaned from the Libor-OIS spread, or the difference between the interest rate on an unsecured loan and the risk-free overnight interest rate. Essentially, the spread is a proxy for credit risks in the banking sector. The wider the spread, the higher the perceived risk of lending. When banks refuse to lend, liquidity conditions may seize up and trigger a domino effect in the broader economy as companies may not be able to access funding and may cease to operate.

Fortunately, following the Federal Reserve’s dramatic action to ease US Dollar funding conditions, the Libor-OIS spread has stabilised and appears to be moving gradually lower. Amid the current unique circumstances, this signals an improvement in US Dollar liquidity conditions.

Seek exposure prudently

For investors sitting on idle cash, or are underweight equities, they may seek to gradually accumulate quality stocks in Asia.

In addition, given the rocky and uncertain market terrain, investors may also consider gaining exposure to the region via an actively managed and well-diversified portfolio.

In this area, we would prefer equity investment strategies that invest in quality, dividend-yielding stocks with healthy balance sheets, earnings visibility and cash-flows. Also, an income-focussed, balanced multi-asset approach might be another prudent way to gain exposure to Asia amid the turbulent environment.

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