While Western economies are only just beginning to show the first signs of the scale of the Covid-19 economic shock, markets want to anticipate recovery. Certainly, we expect a strategic multi-year opportunity in higher-quality credit, Baa or otherwise. But on the growth outlook, we are skeptical of some of the assumed trajectories.
Western market participants often have a fixed set of scenarios for future growth, parameterized by letters of the alphabet, including V, U, W or L-shaped. But, not only is this an investment-writing cliché, we think it is also a false choice for Covid-19.
Just because our Western alphabet has been around since Etruscan times does not make its letters the best economic guide. The letters V and W, with their sharp bounces, and mean-reversion assumptions, seem to belong to a 1945-2007 world, a prior era compared to post-2008 structural trends. U seems to ignore ten years of lower growth and rates. The letter L seems more suited for Japan.
Covid-19 poses new market and economic questions: we have the competing theories and scenarios of epidemiologists, the second derivative of new infections and the flattening of curves (infection curves, not US Treasuries or credit maturity curves).
We think 2020-21 growth trajectories are better described by the Arabic letter Baa’, in its final form (Figure 1). In an age of lower secular growth trends, low rates, older demographics and higher debt, the elongated horizontal sweeps of the Arabic alphabet seem a better fit than western equivalents.
The consensus expects -16% (quarter-on-quarter, annualized) US GDP growth for Q2, and -1.5% for 2020. The Euro Area Q2 numbers are similar, with full-year 2020 forecasts at -3.5% (based on a selection of recent broker forecasts). We suspect the downgrades to growth, earnings and sovereign and corporate credit ratings aren’t over. All in, our base case sees 2020 real GDP in the US, and the Eurozone at least matching the full-year 2009 economic contractions of respectively about -3% and -4.5%.
Given the massive fiscal easing, we expect government budget deficits of at least 8-12% of GDP. This is necessary in the short term. Yet, further out, it proffers higher sovereign debt burdens and fiscal drag.
Fixed Income opportunities are shifting swiftly away from safe-haven government bonds towards credit.
We think the best allocation opportunities are now gradually to build long positions in investment grade credit, and in BB high yield. We are cautious on emerging market (EM) hard and local currency, and view EM FX mainly as a risk hedge against credit longs. The potential for rolling crises means there are plenty of parts of the EM universe to avoid.
For all of Q2-Q4 2019, we saw very little opportunity in credit. It is hard – but crucial – to be disciplined and patient when spreads are tight and when both valuations and fundamentals are late cycle, regardless of short-term incentives of chasing carry. We came into the Covid-19 volatility with an overweight in EUR investment grade versus an underweight in USD investment grade. We had betas of just over one, and a zero net exposure in high yield. This sets us up with fire power for the current opportunity.
What a change March 2020 has brought. We are now at credit spread levels seen only for the third time since the 1930s: in the early 1980s, 2008 and now, based on Federal Reserve and ICE BofAML data. Policymakers have stepped in, with the Fed breaking new ground by joining the ECB and Bank of England in buying corporate bonds.
On a cross-sectional basis, we find investment grade credit, especially primary, long-dated USD, to be the best opportunity. We look for bottom-up balance sheet quality and cyclical resilience. Next, we favor EUR investment grade, followed by non-energy BBs in EUR and USD.
The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).
This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.
This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.