The prospect of a second wave of infections has been top of the list of downside economic and financial risks for some time now. The problem is that the current pickup in infections in SA, the US, Brazil and Iran cannot be defined as a second wave when the first wave hasn’t even passed.
Financial markets voted with their feet last week at the end of what could have been a bumper quarter, if not for the coronavirus setback appearing during June. Stock market losses in the advanced economies and South Africa are still only in the single digits, having recovered more than 40% from the March bear market low.
Last week alone, though, the S&P 500 Index shed 3% as the most populated states in the US, Texas, Florida and California, saw steep increases in infection rates and no sign of this levelling off, let alone reducing.
The second quarter was a wild ride for the stock markets and economies and that looks set to continue. Already dire forecasts for growth this year could be even worse should the virus not be brought under control. Already the IMF has considerably lowered its global growth forecast for this year and next on the premise that there were worse than anticipated outcomes in the first half of this year and there is an expectation of more persistent social distancing into the second half of this year, which would be damaging to supply.
At the end of the second quarter, a question weighing on investors’ minds is whether the still-elevated levels of the equity markets around the world are out of touch with the current and likely economic realities.
While pointing out that exceptional support from the $10 trillion government stimulus packages has helped avert an even worse economic scenario by improving livelihoods and preventing large scale bankruptcies, they have also been behind the strong upward rally in financial markets. The Fund points out is worrying because the market’s gains are disconnected with real underlying economic conditions and “raises concerns of excessive risk-taking”.
In a note, Blackrock also asks the question whether the market has “moved too far, too fast” and whether all or most, of the good news, has been priced in already. The asset manager says there are equal reasons to be optimistic and cautious as financial markets enter the second half of the year.
Its reasons for optimism are that the US economy was solid before the pandemic struck, the credible, coordinated policy response has helped ease conditions and it sees equities as offering attractive value relative to bonds.
Reasons to be cautious, however, are the risk of a second wave of infection; heightened geopolitical tensions and absolute equity valuations that are not cheap
Blackrock’s prognosis for equity markets is that stocks are unlikely to retest the March lows but it admits that the market has moved “very far, very fast and it is prudent to prepare for further volatility.”
Russell Investments cautions that markets, supported by the vast fiscal and monetary stimulus and economic re-openings, are at greater risk of pulling back on negative news “as support from oversold conditions wanes”.
South African equities have outperformed the US year-to-date, with the JSE All Share Index 5.7% lower year to date compared with the S&P 500’s 6.2% decline.
Given the many challenges the country faces as we enter the second half the year, the outlook for the financial markets looks even more precarious than at the end of the first quarter. COVID-19 presents a clear and present danger; the fiscal burden looms over the economy, with Fitch indicating that it doesn’t believe South Africa will achieve its debt stabilisation target, and there are growing concerns about the sustainability of the emerging market universe as a whole.
Given the state of the government’s finances and the massive funding it needs to secure from the private sector, the bond market may present more of a risk to investors than the equity market. Old Mutual Multi Managers investment strategist Izak Odendaal says the issue of market confidence is trickier and essentially unpredictable. “As we saw in March and April when foreigners sold R80 billion of bonds and yields spiked, a loss of confidence can come out of the blue. It is usually the result of a global crisis episode, but domestic events can also be the cause, such Nenegate in December 2015 (though the firing of then Finance Minister Nene occurred against the backdrop of an emerging market sell-off).”
He adds that both these episodes were short-lived, however, and a complete and sustained Argentina-style collapse in confidence would be another kettle of fish. Domestic investors can reach a point where they will no longer want to absorb increasing debt, says Odendaal. “The warning sign will be when government’s weekly bond auctions start failing. So far, these are still oversubscribed even though the size of the auctions have increased.”
To maintain market confidence, South Africa needs faster economic growth to stabilise government debt. Odendaal says there are only four things the government can really do to release the ‘animal spirits’ of the private sector and raise the growth rate post-lockdown.
These include reducing policy uncertainty in mining and agriculture; cutting red tape to enable skilled immigration and tourism; increasing municipal efficiency and, lastly, crowding in the private sector so that it can participate in areas currently monopolised by SOEs. On the latter, he sees the announcement at the presidential infrastructure summit last week that there are 55 “bankable and shovel-ready” infrastructure projects open to private sector investors as a positive.
But in the end, the state of the economy and financial markets here and globally will hinge on getting the spread of the virus under control – and, sadly, as we head into the fourth quarter and second half of the year, it seems we are no closer to doing that than when we were at the end of the second quarter. BM/DM