Ron Temple
The global economy requires three key building blocks to ‘exit’ COVID-19 in the safest, most effective way possible, according to Lazard Asset Management.
In a note to investors, Ron Temple, Co-Head of Multi-Asset and Head of US Equity, argued that improvements in healthcare systems, economic implications, and monetary policies, will enable the global economy to effectively leave the COVID-19 pandemic.
1. Healthcare systems
Testing: With more than 550,000 new coronavirus cases, global infections increased to 3.45 million, while deaths exceeded 244,000 as of 3 May. The United States accounted for 33% of the global infections and 27% of deaths. Encouragingly, new infection and death rates continued to decline in Spain, Italy, France, Germany, and in the US states that have restricted mobility the most.
Testing remains a top priority. Very few countries are testing widely enough to identify asymptomatic carriers of the virus. While the UK and France made significant progress in accelerating the pace, the US tested only around 10% more people than in the prior week. Estimates for the number of tests needed in the US to facilitate reopening the economy range widely, anywhere from 3 million per week to 5 million per day. What is easily agreed is that current testing in the US remains far below the lower bound of this range.
Therapies: Gilead’s antiviral drug remdesivir made headlines this past week with a successful clinical trial that accelerated recovery in patients hospitalized with COVID-19. On the back of this development, we adjusted our three scenarios for economic recovery to a more optimistic setting. In our base case, sustained recovery now begins in the third quarter of this year.
We believe that remdesivir, although not a cure for COVID-19, significantly truncates the left-tail, or worst-case, scenarios related to the pandemic.
Vaccines: Although vaccines historically have taken years to develop, in the case of COVID-19, we are optimistic that the timeline will be compressed based on a) the amount of funding and focus on development, with six vaccines already in clinical trials, b) the fact that many steps in the development process are being conducted in parallel rather than in sequence, and c) the breadth of novel and proven modalities currently being evaluated. We are encouraged by the magnitude of research efforts underway by so many firms.
2. Economic implications
Despite the positive therapy news, the pandemic continued to wreak havoc on the economy, with 3.8 million more Americans claiming jobless benefits last week, taking total claims to 30.3 million in only six weeks. In Europe, 10 million workers at 425,000 companies are now covered by special unemployment schemes in France, while 4.6 million are covered in Italy. In Germany, 718,000 companies have applied for the government’s short-term special work program.
Nevertheless, we have revised our three primary scenarios for economic recovery given the positive news on remdesivir. We now think a sustained recovery will begin sooner and unemployment will peak more quickly. However, we remain concerned about the potential for the pandemic to have lasting effects on growth.
Countries and companies are likely to exit the crisis with significantly higher debt, curtailing their ability to invest and innovate. We also expect to see some behavioural changes endure, such as more people working from home. That particular change would reduce the amount of miles car commuters drive every day, decreasing demand for oil and automobiles, as well as for office space in city centres.
Finally, we believe companies and governments around the world are likely to reassess the desirability of complex global supply chains, especially in essential areas such as healthcare and food, in light of the supply challenges that occurred during the crisis.
US-China tensions: Another factor clouding the long-term outlook: more intense US accusations against China regarding the origins of the virus and the transparency of China’s disclosures. The latest accusations by the Trump Administration–speculating that COVID-19 was accidentally released from a Chinese laboratory in Wuhan that has dual military-use purposes–in part resurrected suspicions that had been largely dismissed by experts several months ago. The US also accused China of obstructing the flow of information about the virus in ways that increased the severity of the pandemic. Australia joined the US in supporting a global investigation of China’s response, which only heightened tensions further.
While we do not see an imminent re-escalation in the trade war, the economic recovery would unquestionably be impaired by new tariffs or restrictions on trade that increase uncertainty for companies and consumers.
3. Monetary policy measures
During the week the Fed announced an expansion in the Main Street Liquidity Facility, opening the door further to non-investment grade borrowers tapping its facilities. Under the new terms, companies with fewer than 15,000 employees or revenue of less than $5 billion can apply for loans. Also, while the original guidelines on 9 April limited borrowing to $150 million, the Main Street Expanded Loan Facility now can lend up to $200 million at an interest rate of LIBOR + 300 basis points (bps). Borrowers cannot exceed a debt-to-EBITDA ratio of 6x with the incremental funding and must have a “pass” rating from the Federal Financial Institution Examination Council as of 31 December 2019.
In Europe, the European Central Bank (ECB) disappointed investors by not expanding its Pandemic Emergency Purchase Programme (PEPP) to include debt issued by companies that have been downgraded below investment grade since 7 April. During a press conference, ECB President Christine Lagarde emphasized repeatedly that the ECB has been, and will remain, flexible and will do whatever is required to support the economy and achieve its mandated inflation objective. Nevertheless, the questions during the conference implied that the markets do want more aggressive action from the ECB.
During the week, the Fed added $83 billion to its balance sheet, which stood at $6.66 trillion. This was the smallest increase since the week ended 4 March. The decelerating growth reflects slower purchases of both Treasuries ($62 billion) and mortgage-backed securities (MBS), though the $18 billion drop in its holdings was more than offset by a $38 billion increase in commitments to purchase MBS that have not yet settled. The ECB balance sheet grew by €64 billion to €5.35 trillion with purchases of €26 billion in securities in the PEPP and a net €9 billion under the Public Asset Purchase Programme focused on sovereign debt. The other increases resulted from financial institutions tapping the longer-term refinancing operations facility for €19 billion.
Investor takeaways
For investors, we continue to recommend focusing on security selection and prioritizing quality in issuers’ balance sheets, funding profiles, and ability to generate high returns on capital through the cycle.
For debt investors in particular, we believe that some highly leveraged issuers and structured securities remain unattractive and suggest emphasizing detailed cash flow analysis of all issuers. Of note, spreads on investment grade debt remain substantially above pre-crisis levels, and investors should not feel forced down the quality spectrum to generate income.
In the equity markets, we see excellent franchises trading at significant discounts to fair value and to levels of only a few months ago. While it is critical for investors to assess the near term and ensure that companies are not likely to encounter liquidity-related stress, it is also vital to recognize that the value of a company’s stock is the present value of all future cash flows to which shareholders are entitled. In other words, one or two years of weaker earnings may amount to a short-term reduction in cash flow rather than a permanent change in earnings potential.
