By Rebecca Ellis
TUE, 01 DEC, 2020-theGBJournal- Global stocks had their best month on record, propelled by a series of Covid-19 vaccine breakthroughs and optimism over Joe Biden’s victory in the US presidential election. Yields in the bond markets which have been trending lower for the past three decades resumed their downward trend: Portugal- which the EU had to bail out in 2011 – saw its 10-year bond yield fall below zero for the first time last week, as expectations of further asset purchases by the European Central Bank continued to stoke a relentless rally in eurozone debt.
What is a boon for equity investors is a dilemma for savers? When growth, inflation and interest rates are low, savers tend to export their capital to economies that are growing or go ‘down’ the credit curve i.e. piling into riskier positions. This trend was first witnesses in Japan and maybe replicated now as other countries may soon produce their own legions of market-moving retail investors as ultra-loose monetary policy spreads more widely across advanced economies. By forcing investors into a search for yield, the central banks have also ensured that credit risk is being mispriced. A striking example last week was Peru issuing sovereign debt with a 100-year term and a coupon of 3.23% immediately after a constitutional crisis. Investors ultimately have no place to go except to the ever fragile high-interest countries such as Turkey or South Africa that the local smart money is desperate to leave.
So far in 2020, we have seen a considerable shift to the US investment-grade bond market: Bond fund managers have lapped up the record pace of new debt sales since March. By the end of June US investment-grade debt sales totalled USD 1,225bn for the year to date versus USD 597.4bn over the same period in 2019. Yield has dropped from a paltry average of 4.08% at the end of 2019 to an even lower 3.52% average in the third quarter of 2020.
The corporate credit market has been propped up by several central banks and for good reason. Contain credit stress and you appease the equity market is the current policy approach. No one wants the current pandemic recession to become a financial crisis via a surge in credit market volatility. The ultimate backstop has not just reversed the pandemic-inspired rout of credit it also triggered an avalanche of corporate debt sales at ever longer average maturities. This has bought companies breathing room and allowed them to build reserves that hopefully tide them over until the economy recovers. This leaves investors greatly exposed to a sudden rout in the credit market outside of the most benign scenario where the economy and companies muddle through the pandemic: either a nasty downgrade and default cycle, will come back to haunt them, or a sharper rebound for the economy along with some inflationary pressure will also prompt a quick exit from credit. In both scenarios, central banks will have their work cut out to stem credit angst and its repercussion into other markets.
The European Central Bank has sent fresh signals that it is gearing up to inject more monetary stimulus into the eurozone’s flagging economy, citing worrying signals that financial conditions for banks and small businesses are tightening. The ECB is worried about the possibility of a mutually reinforcing adverse loop if banks view falling loan demand as a negative indicator for the economy and companies draw the same conclusion as banks tighten their lending criteria. There is a risk of an unwarranted tightening of funding conditions if governments delivered an insufficient fiscal response to the economic fallout from the pandemic.
The Central banks’ support for the credit market seems assured for now while governments’ fiscal responses may fall prey to internal bickering and horse-trading which currently prevents the disbursement of the EU support programs and the conclusion of another US stimulus package.
The equity rally looks to rest on solid grounds. In its outlook for the year ahead — a tradition that banks have bravely stuck with despite the painfully short shelf life of the 2020 predictions — Goldman Sachs expects the US S&P 500 equity index to reach as high as 4,300 by the end of next year. That would be a near 20 per cent rally from current levels.
Meanwhile, shoppers in the US were splashing out billions of dollars from their smartphones and laptops on Black Friday as those who have never shopped online before fuel a boom in ecommerce, leaving shopping malls deserted. Mall watchers reported sharply lower footfall than usual on what is traditionally the busiest shopping day of the year. Amazon, Walmart and Target were on track to be among the biggest corporate winners from a surge in digital spending, consolidating their lead over struggling more traditional rivals. As equity investors, a position in ecommerce, gaming, streaming and the cloud – the winners of the pandemic – remains a low-risk, high-reward investment.
Rebecca Ellis is a Personal investment advisor, based in Zurich| rebecca.ellis@pomonawealth.com|pascal.crepin@pomonawealth.com
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