THE COVID-19 FACTOR
Containment measures are dragging growth lower but should eventually lead to a less-prolonged downturn.
THE ECONOMIC IMPLICATIONS
Swift global monetary and fiscal policy could pave the way for an economic rebound later this year.
We believe current valuations could offer compelling opportunities, especially for active managers.
Loomis Sayles has proprietary US credit risk premium models that help us measure how far prices typically depart from fundamentals during times of market stress. These models have reached levels that suggest investors may now be adequately compensated for stepping into the markets.
It will likely take months for the credit cycle to turn toward the more favorable credit repair phase. That said, current valuations could offer some attractive opportunities, especially for active managers.
Fiscal and monetary policies are providing tremendous support to small and large businesses in the US, but we currently expect defaults to accelerate in the high yield sector. We also anticipate credit rating downgrades in the investment grade sector.
Long-duration corporate bonds are facing limited interest-rate risk in our view, given that we do not expect Treasury yields to rise much. The Fed has established two new programs to facilitate purchases of investment grade corporate bonds in the primary and secondary market. The facilities are already yielding positive results.
The Fed is also supporting liquidity in the securitized credit market by purchasing agency commercial and residential mortgage-backed securities.
TREASURYS & GOVERNMENT BONDS
We are reluctant to call a bottom in developed market bond yields under current conditions.
Ten-year yields in Japan and several European countries have already spent time below zero. We see a low probability of a severe downturn, but if one occurs, we would not be surprised to see negative US Treasury yields.
We believe negative policy rates in the US are unlikely because they disrupt the financial sector and have not shown their worth in Europe or Japan.
Long-term developed-market yields are facing the same set of primary drivers—limited inflation pressure, ultra-low monetary policy rates, demand for relative safe-haven assets and periodic risk aversion. These drivers appear to be preventing a sustainable rise in yields. This condition is generally good for borrowers but not for savers.
Several central banks are participating in financial markets, purchasing securities and seeking to provide liquidity to soothe fixed income volatility. We expect the Fed’s balance sheet to rise substantially.
We believe weak corporate profits lie ahead, but many equity markets have already priced in a mild downturn.
We expect significantly above-average market volatility to persist while the depth of the economic and corporate profit downturns remain uncertain.
We expect weak S&P 500 first-quarter 2020 earnings, and second-quarter earnings are likely to be even weaker. We are anticipating some sequential improvement in the third quarter, and we see potential for modest year-over-year growth in the fourth quarter.
We believe S&P 500 profits may contract 25% to 30% in calendar year 2020.
Equity markets have already discounted a mild downturn in the global economy. We believe investors with a time horizon of one year or longer should consider allocating to equities during this volatile time.
We believe that if governments do not act swiftly to contain the virus, we could face a severe, prolonged downturn.
The longer it takes to reach a peak in new COVID-19 cases, the longer it will likely take to lift quarantines and resume normal economic activity. We believe governments need to act swiftly to minimize the economic damage.
Risk markets have already discounted a mild downturn scenario, but if the shock becomes more severe, the eventual recovery in risk assets will take longer than we currently expect.
A key silver lining is the fiscal and monetary policy response to the outbreak, which has been rapid and of significant magnitude.
ASSET CLASS OUTLOOK
This commentary is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but Loomis Sayles cannot guarantee its accuracy. This information is subject to change at any time without notice.
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