Politics and economy

Strict regulations in private and professional life are intended to contain or control the spread of the coronavirus. Aid packages of USD 2 trillion in the USA and EUR 540 billion in Europe are available to minimize the impact on the respective economies. Both are remarkable considering that the US is spending around 10% of GDP and that Europe was previously unable to agree on the Brexit gap in its budget. But because the economy is suffering on both the supply and demand sides, a recession is almost inevitable.

A comparison with the 2008 financial crisis is misleading; the 1930s depression is a better yardstick. The term “depression” was last used for the Great Depression in the late 1920s. As the low point of an economic downturn, it is characterized by high unemployment, low capacity utilization, falling incomes and lower demand. Conditions like those today.

 

Monetary policy and bond markets

In view of the risks to the economy and economic growth, central banks have taken action. The Fed has now lowered the key interest rate to 0-0.25% and announced major securities buybacks. These consisted of purchases of US government bonds and mortgage-backed securities. In addition, “corona emergency loans” are now granted and liquidity swaps with other central banks have been expanded. An additional measure concerns a new repo facility through which foreign authorities can obtain USD at a low interest rate by selling US government bonds.

The ECB has refrained from lowering interest rates but has instead initiated various emergency measures. For one year, the banks will receive a premium of 0.75% for refinancing loans if they do not reduce their credit volume. Additional bond purchases of EUR 120 billion have now been increased by EUR 750 billion. Cooperation with the European Stability Fund (ESM) and a suspension of the self-imposed restrictions on the upper limit for purchases of government securities of individual countries are also under discussion.

The biggest problem in the bond markets is the record level of debt of companies whose bonds are currently worth USD 20.9 trillion or 92% of GNP. Just under half of the bonds are not investment grade (BBB), only just over 25% are better rated. In the current environment, however, even government bonds of industrialized nations are no longer safe havens. On the one hand, many investors (hedge funds, bond-ETFs) are liquidating in order to have as much cash as possible; on the other hand, initial fears of inflation are making the rounds. In the longer term, the most worrying aspect is the fact that central banks are not only indirectly financing government spending.

 

Stock markets

All economists and analysts have to revise their forecasts, but since everything is still in motion, reasonable figures are impossible. Nonetheless, even without empirical figures, there is a consensus that the global economy is already in recession and that the correction was entirely justified. The questions regarding the depth and length of this economic slowdown will remain pure speculation until the first economic figures are available. The stock markets still have to cope with considerably worse quarterly results.

At the moment, emotions and hopes are determining price movements. Any “improvement” in the number of tests, infected persons or deaths are gratefully received and evaluated as a sign of speedy recovery. Every action by the authorities is associated with the hope of early improvement. The consequences for the business of listed companies are ignored, and the forthcoming changes in the evaluation criteria still need to be processed.

 

Conclusions

Since the present problem is equivalent to squaring the circle, “caution is the better part of valour” (Falstaff, Shakespeare). Politicians may relax protective measures too soon, and the economy could suffer more damage than expected. Bonds should be scrutinized for the creditworthiness of the company (do not rely on rating!), shares for the financing of the company (look out for goodwill!). The IMF forecast of a 3% contraction in the global economy compared with the previous year is too optimistic, and the 5.9% cash holdings of fund managers (BoA survey) are too low.

 

 

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Christian Wagner
Financial Advisor