Born to Run


"In the day we sweat it out on the streets of a runaway American dream. At night we ride mansions of glory in suicide machines." These are unquestionably some of the best lyrics ever written by the Boss, but, I have not got the foggiest idea about what they mean. Perhaps Springsteen was using the metaphor to describe the push / pull struggle between top down gloomy economists and the bottom up exuberance of equity markets? 

The inscrutable conflict between economists and equity markets has played out through the second quarter of this year and will hopefully resolve before the end of the year. In the meantime, we caution against confusing a rebound in markets for an economic recovery. In working towards this resolution, we will continue to battle the pandemic, endure the US Presidential election campaign and watch the UK leave Europe with or without a deal. 2021 promises to be a very different year, but we can only hope that it will make more sense than this less than perfect vision of 2020.

In January this year, before COVID-19 was properly on our radar, the IMF forecast global growth to be +3.3% in 2020. That was swiftly revised down to a fall of -3% in the April edition of their World Economic Outlook and then again in June (Figure 1). 

Figure 1: IMF 2020 GDP forecasts from last three World Economic Outlook Projections


When the April forecasts hit the news wires they caused quite a stir, aggressively marking down growth prospects and representing the first analysis of lockdown from an independent supranational agency. 

The World Bank and then the OECD followed in Q2 representing increasingly dire markdowns to economic activity until finally the gloomiest forecasts yet were presented in the IMF’s third attempt at -4.9%. The more economists learn about lockdown the less they like it. 

When we compare the top down, worst recession in living memory, with the bottom up company analyst Earnings Per Share (EPS) forecasts, the conundrum becomes clear.

Analysts are expecting the financial impact of lockdown to hurt corporates, but not as badly as the last recession in 2007/8 (Figure 2). Admittedly analysts have a history of being too optimistic about the companies they follow and too slow to take on board poor news flow. 

Figure 2: US Analysts' consensus EPS growth forecasts


When we compare the EPS growth forecasts to the ISM manufacturing survey of US companies, the similarities are undeniable (Figure 3). Growth expectations from the bottom up correspond well. Not only that, but expectations are not as sour as they were at the last recession. Top down economists are seeing more of a COVID-19 growth roadblock than corporates and analysts.

Figure 3: US ISM Manufacturing PMI versus Consensus EPS growth


Policy makers have already made Herculean efforts to stop the wheels falling off, perhaps best seen when looking at the substantial intervention from both fiscal and monetary policy. Using IMF estimates (Figure 4), they suggest that the change in global government debt this year is likely nearly twice that seen in response to the last recession and deficits are likely to be twice as large. Not only that, but the liquidity provided from the US Federal Reserve (Fed) has been both massive and timely. Policy makers have already more than matched the interventions from the last crisis and there is likely to be more required.

The Fed’s balance sheet (effectively the money it has printed for Quantitative Easing(QE)) was shrinking as a proportion of GDP right up until Q1 this year (Figure 5). COVID-19 forced dramatic monetary and fiscal action from central bankers and governments that has been unprecedented in peace time. That said, these measures have, so far, been about providing liquidity and keeping employees attached to their employer. All necessary and laudable policy aims, but what next? Unless economies can start to grow again soon, companies are going to face a solvency crisis, and the unemployed quickly become unemployable.

Figure 4: Change in Global Government Debt and Overall Fiscal Balance %GDP
Figure 5: Fed balance sheet %GDP


The direct evidence on US large corporate failures seems reassuring (Figure 6) with rates of bankruptcy no higher than its usual mid cycle range. More than that, the BBB credit spread, which spiked above 300 basis points as the lockdown began, has since narrowed considerably. Credit spreads have, in the past, provided a useful leading indicator on corporate stress and bankruptcies. Taken at face value, the prospects for corporate solvency seems to be improving. The Feds bond buying program, however, includes corporate debt which is forcing yields down and narrowing spreads against treasuries.

In the same way that the yield curve has become distorted and is no longer a reliable signal of prospective growth, credit spreads have been artificially compressed as part of QE. A more simplistic way of looking at solvency would be to ask how likely are companies to survive a second or indeed a third lockdown? New COVID-19 cases (Figure 7) are rising at an alarming rate. Fauci’s warning of 100k daily COVID-19 cases seems perilously close.

Figure 6: US Bankruptcy Index versus BBB credit spreads
Figure 7: Daily confirmed COVID-19 cases


The politicisation of PPE in the US has been abhorrent, and President Trump is now suffering for that, amongst other things, in the polls. The implied probability of Joe Biden winning over President Trump (Figure 8) has been gaining momentum since May. A lot can happen between now and the election, and President Trump has form winning on a late surge, but as things stand, his campaign is not in good shape. Joe Biden is now regularly raising more funds than his republican counterpart, and the equity market seems to have grown comfortable with a possible blue win.

Figure 8: US Presidential implied probability of Biden-Trump winning


Tech is likely to remain a winner into the new cycle (Figure 9) but the possibility of a Biden victory may have implications for healthcare and infrastructure. 

Figure 9: US Equity Markets Indices


With the radical Green New Deal now history, a more centrist set of growth policies may prove acceptable for capitalists. Healthcare companies may continue to do well in an expansion of Obamacare, although a more radical, “free at the point of use, NHS” style agenda, while not unthinkable after COVID-19, may prove too much for markets. Trade policy is unlikely to change much, however, the frosty relations with China seem inevitable no matter which party wins this autumn.

There are, however, some worrying signs beneath the surface. The receding cyclical/defensive ratio (Figure 10) suggests that broader market gains are not being underwritten by companies geared into prospective growth. Without that, the equity recovery looks fragile and central bank related. Equities have priced for perfection, anything short of that risks a further pullback in valuations. While we have been pleasantly surprised by recent market moves and economic news flow, we remain cautious.

Figure 10: US cyclical versus defensive (ex tech) against the S&P500


“The amusement park rises bold and stark, kids are huddled on the beach in a mist. I wanna die with you, Wendy, on the streets tonight in an everlasting kiss.” Clearly Bruce at his prophetic best and sounding positively post COVID-19 for sure. Not bad for a song penned in the early 1970’s. Springsteen may have had powerful foresight, but it is hidden very deeply in his lyrics. Perhaps that is a little like deciphering markets from the clues set out in the economic data. It is easy to misinterpret signals or to over emphasise the wrong things. Amidst the volatility, however, it’s worth remembering that a rebound in markets should not be confused for an economic recovery. We have much further to run yet.



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