A global recession in 2020 is all but confirmed as nations shut down economic activity to limit the spread of COVID-19. The virus is unique in that it is a demand shock and supply shock, and also a negative wealth, oil price, and credit shock. There will be a wide range of subsequent effects. We are monitoring these developments and have updated our previous Stagnation followed by Recession outlook for the U.S. economy to reflect a Recession in March, extending through to the end of the year, as the situation will deteriorate further before beginning to recover.

There is evidence that the disease has likely peaked in China. The Bloomberg China Economic Recovery Index shows that 70% of economic activity was restored by March 9th, up from just 27% at the beginning of February.1 A coordinated global response has started to emerge. Based on the experience in China, virus incidents are unlikely to peak in Europe and the U.S. until June.

The Russia-Saudi spat that has resulted in the current global oil glut and the expected decline in demand due to this pandemic will keep oil prices low with mixed effect across economies. It will have a negative impact on oil-exporting emerging markets outside Asia, while also affecting oil-and-gas related capital expenditure in the U.S. Net oil importers in Europe and Asia will be beneficiaries although the stronger US dollar will offset a portion of the benefit.

In January, a record 31.8 million Americans were employed in retail trade, hotels and motels, air transportation, restaurants and other eating places, arts, entertainment and recreation, and offices of real estate agents & brokers.2 Many of these establishments have seen their businesses collapse in recent weeks and have reduced their payrolls significantly. As we enter the third week in March, 158 million Americans have been told to stay home from work and other activities.3 This doesn’t include the multiplier effects on other industries. Initial unemployment claims and the unemployment rate are soaring and will remain high through the second quarter.

Market behavior in recent weeks has broken records for the speed of its decline. It took only 16 trading sessions for the S&P 500 to fall 20% from its highs, the quickest descent into bear market territory on record.4 U.S. equities were battered in February, down 13% from their peak on February 19th. The S&P 500 was down 8.2%, while smaller caps lagged, with the S&P Midcap 400 and the S&P SmallCap 600 down 9.5% and 9.6%, respectively. The S&P/TSX Composite was down 5.9%.

Asian equities took part in the sell-off, with the S&P Pan Asia BMI closing the month with a decline of 6.6%. European equities struggled in the face of a broader global sell-off. The S&P Europe 350 dropped 8.6% on the month. U.K. equities continued to lag their European counterparts; the S&P United Kingdom declined 9.0% on the month, returning all of its gains from the past 12 months.

In March, we maintained the asset allocation positioning that we established on February 19th. This reflects our view on deflationary and recessionary influences that dominate the global economy.  Allocation to equities was reduced in February to 12% in Tactical Conservative, 17% in Tactical Moderate Growth, 26% in Tactical Growth, and 34% in Tactical Aggressive Growth. In February, within the Fixed Income allocation, we added the 20+ year Treasury Bond. As of March 25th, the 10- year treasury yield has declined by 1.577% since the start of the year, rewarding this position. Gold continues to be present in all models as it performs well in high risk, low yield environments as a risk-free asset class.

Historically, central bank stimulus is bullish for bullion. In the early days of the selloff, safe haven assets such as gold and treasuries sold off when margin calls on equities and credit occurred as equity portfolio managers were sitting with record-low cash buffers. Gold provides diversification in a portfolio and is correlated with the stock market, becoming inversely correlated during periods of stress. In a world of historically low interest rates, gold is a safe-haven. Similar short-term movement was seen in the ten-year note and in State and Local government bonds and Mortgaged Back Securities guaranteed by the federal government in response to liquidity funding requirements.

The shape of the recovery from the pandemic and for the global economy are highly correlated.  The second-order effects of schools closing, businesses closing due to staff absence, and a paralysis in consumer and corporate confidence will create challenges for commerce and credit markets. Policymakers will need to protect both supply and demand by providing ample liquidity to banks and corporations, in order to minimize the risk of default and job losses. The trend towards global populism and protectionism remains a risk to the recovery. We expect to see prolonged disinflation. We will continue to monitor the data for growth, inflation, and recession signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame , President and CIO

 

1Bloomberg. China Economic Recovery Index. March 9, 2020.

2Trading Economics, United States Employed Persons. January 2020.

3New York Times, World Coronavirus Updates. March 23, 2020.

4Financial Times. “S&P 500 suffers its quickest fall into bear market on record”. March 13, 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. February 28, 2020. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The coronavirus outbreak in China has generated economic waves that are disrupting global supply networks that act as the backbone of the global economy and comes as the global economy was already cooling off. Profit warnings from companies with significant operations in China and abroad have begun. We are monitoring these developments and have concluded that our Stagnation outlook for the U.S. economy will shift to Recession beginning in the back half of the twelve-month time horizon.

China is likely heading into a consumer recession, as auto sales there plunged 18% year over year in January to their lowest level in eight years.1 China accounts for 16% of global GDP on a US dollar basis, compared to 4% in 2003.2 In 2019, China accounted for 75% of total world oil demand.3 Commodities markets have tumbled as factories are idled. Iron ore demand is down more than 10% this year. Copper and nickel are down about 8%, while zinc and aluminum are both down more than 5% in 2020.4

In Japan, the world’s third-largest economy declined 1.6% in the fourth quarter of 2019 as the country absorbed the effects of a sales tax hike and a powerful typhoon. It was Japan’s largest contraction compared to the previous quarter since 2014.5

The U.K. and Germany managed to escape a technical recession while France and Italy contracted. Switzerland’s core CPI declined 0.5% sequentially in January. Italy, Germany, and France experienced a 2.7% decline in December industrial production. EU auto sales also declined 7.4% YoY in January.6 The UK’s future trade relationship with the EU remains unanswered. Brexit has already cost the UK economy between 2.5-3.0% of lost output.7 The final economic bill will depend on the extent to which EU trade is disrupted as the UK pursues greater autonomy over regulation, migration, and state aid.

In the U.S. the budget deficit to GDP ratio stands at 4.9%, up from 4.3% a year ago. The last time we saw this level was in May 2013 when the unemployment rate was 400 basis points higher than it is today at 7.5%.8 January nonfarm employment growth was 225,000 jobs. While the unemployment rate ticked up to 3.6%, this increase was driven by a jump in labor force participation.9 The coronavirus impact will be felt in the U.S., resulting in weaker exports, imports, and inventories. Canada’s economy has stalled as transportation activity has been disrupted by blockades set up by anti-pipeline protestors. Real manufacturing shipments fell 0.4% in December and real retail sales were flat. A recent rise in insolvencies comes amid a relatively robust job market.10

U.S. equities started the year strongly, but gains were erased towards the end of the month as a result of coronavirus fears. The S&P 500 was flat in January while the S&P MidCap 400 and the S&P SmallCap 600 were down 2.6% and 4.0%, respectively. Canadian equities were positive, with the S&P/TSX Composite up 1.7%. The S&P Europe 350 finished January with a loss of 1.3%, ending a four-month streak of gains. The S&P United Kingdom lagged its European counterparts in January, with the index declining 3.3% in pound sterling terms. U.S. fixed income performance was positive across the board, with treasuries and corporates leading the way. The decline in the U.S. long bond’s yield reflects a confluence of factors including easy Federal Reserve monetary policy, concerns about the COVID-19 epidemic’s impact on economic growth, and an absence of inflationary pressures. Gold is continuing its advance, after breaking out from a six-year base formation, rising as the US dollar rises, not the usual correlation.

In February, we reduced exposure to U.S. equities across all models and reintroduced the U.S. long-term Treasury Bond. This reflects our view on deflationary influences that dominate the global economy. Allocation to equities was reduced to 12% in Tactical Conservative, 17% in Tactical Moderate Growth, 26% in Tactical Growth, and 34% in Tactical Aggressive Growth. Within the Fixed Income allocation, we added the 20+ year Treasury Bond as long rates are expected to decline further. Gold continues to be present in all models as it performs well in high risk, low yield environments as a risk-free asset class.

The trend towards populism and protectionist policy remains a risk to the stability of global financial markets and the COVID-19 outbreak is likely to delay recovery and intensify disinflation. We will continue to monitor the data for growth, inflation, and recession signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

Trading Economics, China Vehicle Sales. February 13, 2020.

Visual Capitalist. 70 Years of China Economic Growth. October 12, 2019.

Trading Economics, China Imports of Fuel Oil. February 2020.

Trading Economics, Commodity Prices. February 2020.

Trading Economics, Japan Q4 2019 GDP. February 2020.

Trading Economics, E.U. Economic Data. February 2020.

Oxford Economics. Brexit. February 2020.

Trading Economics, U.S. Debt to GDP. February 2020.

Trading Economics, U.S. Non-Farm Payrolls. February 2020.

10 Trading Economics, Canada Insolvencies. February 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. January 31, 2020. Index performance is based on total returns and expressed in the local currency of the index.

Global growth is projected to reach 2.5% in 20201. Reduced trade uncertainty combined with last year’s easing in financial conditions helped business sentiment stabilize in many major economies. The U.S. dollar benefitted from safe-haven demand over the past year amid this trade uncertainty. Global manufacturing activity generally remains soft; the global manufacturing PMI fell to 50.1 in December, consistent with stagnation.2 Trade challenges between the world’s two largest economies are likely to continue, with no long-term deal to tackle structural issues and imbalances between the U.S. and China. Growth forecasts for advanced and developing economies have been revised down as a result of weaker than expected trade and manufacturing activity. We are monitoring these developments and have concluded that our Stagnation outlook for the U.S. economy over our forecast time horizon of twelve months still stands, with a recession likely in 2021.

GDP growth in China has slowed to 6% in the third quarter of 2019, its slowest pace in about 30 years.3 Policymakers are focused on measures to limit risks arising from excessive debt burdens, even if it means weaker rates of growth. An uptick in infrastructure projects towards the end of last year has been the main driver of growth. Eurozone growth continues to underperform, dampened by the gradual slowdown in China, the ongoing Brexit saga, White House protectionism, and the threat of more tariffs. The accommodative policy measures implemented by the ECB and fiscal policy should continue to prop up the economy. Concern grows about the corrosive side effects of negative interest rates as the ECB’s bond-buying program nears its self-imposed limits.

The U.S. leads the global charge as their economy is entering its eleventh year of expansion, the longest on record. The consumer remains the main source of strength due to strong job gains and low interest rates that have bolstered spending. While the U.S. has proven successful in securing a trade deal with Canada and Mexico and extracting a “phase one” trade agreement with China, vulnerabilities remain due to their sizeable trade deficit. As a share of GDP, the U.S.’s goods trade deficit over the last two years has narrowed only marginally below the last decade average, driven mainly by a slight reduction in U.S. import demand, where lower merchandise imports from China have been replaced by imports from Mexico, Europe, and developing countries in Asia.4 The PMI for the sector hit its lowest level in a decade in December.5 Conflicts in Iraq and Afghanistan have left the American public strongly opposed to further major conflicts in the Middle East and a direct conflict with Iran would raise downside risks to business activity. For Canada, healthy demand stateside and receding North American (USMCA) trade tensions helped facilitate the much-needed rotation towards exports and business investment from the consumer and housing sector in the fourth quarter.

One of the most notable effects of last year’s Fed rate cuts was support for asset prices. U.S. equities ended 2019 strongly with the S&P 500 up 31.5% for the year, despite lackluster profits, slowing global growth, and recession fears. It is worth noting that a late-2018 selloff provided a flattering comparison for 2019. Mega-caps dominated as gains for the S&P MidCap 400 and the S&P SmallCap 600 were 26.2% and 22.8% for the year, and 2.8% and 3.0% for December, respectively, while the S&P 500 was up 3.0% for the month. U.S. fixed income performance was positive across the board. The S&P/TSX Composite gained 22.9% during 2019 and was up 0.5% in December, closing out the decade with its best annual performance since 2009. European equities also experienced their best year since 2009 with S&P Europe 350 up 27.2% for the year and 2.1% for December. The S&P United Kingdom finished 2019 up 17.2% for the year. Commodities also rallied, with the DJCI up 10.1% and the S&P GSCI up 17.6% for the year, driven by gains in Energy and Precious Metals.

In January we maintained the December allocation between Equities and Fixed Income across all models. Allocation to equities remains at 17% in Tactical Conservative, 22% in Tactical Moderate Growth, 36% in Tactical Growth, and 44% in Tactical Aggressive Growth. Within the Fixed Income allocation, we maintained the weight of the 7-10-year maturity in order to protect the portfolio from a rebound in long rates. Gold continues to be present in all models as it performs well in high risk, low yield environments as a risk-free asset class.

The trend towards populism and protectionist policy remains a risk to the stability of global financial markets while heightened geopolitical strains also have the potential to create volatility. We will continue to monitor the data for growth, inflation, and recession signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame , President and CIO

 

The World Bank Group. Flagship Report. Global Economic Prospects. January 2020.

2 J.P. Morgan Global Manufacturing PMI. News Release. January 2, 2020

Trading Economics. China GDP. January 20, 2020.

Trading Economics. U.S. Goods Trade Deficit. November 26, 2019.

Trading Economics. U.S. PMI. January 2020.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. December 31, 2019. Index performance is based on total returns and expressed in the local currency of the index.