On the November PGIM Global Partners CIO call hosted by QMA, chief investment officers and senior investment professionals from PGIM's international businesses, PGIM Fixed Income and QMA discussed the ongoing recovery in the global economy, the rally in the stock markets and the outlook for financial markets.
Stocks posted solid gains in early October on optimism about the US congress passing a fiscal stimulus package and as Chinese markets opened strongly following an eight-day holiday. However, the rally fizzled in late October with reduced odds of a fiscal stimulus package being passed before the November 3rd elections and rising COVID-19 cases in the US and Europe. Developed market stocks declined -3% in October, taking year-to-date losses to -1%. Emerging market stocks gained 2.1% (US$) in October. Developed market sovereign bond yields drifted higher in the US and UK last month.
After declines in September and October, stocks started November on a strong note on hopes of a large fiscal stimulus program due to pre-election expectations of a Biden victory and a "Blue Wave." However, with lowered expectations of the Democrats taking the US Senate, markets continued to rally, as prospects of a divided government have reduced the odds of tax hikes and increased regulation under a Biden administration.
The November CIO Call participants discussed the outlook for financial markets and the global economy in the aftermath of the US elections and a potential change in US administration and policies, and against the backdrop of a fresh wave of infections that could prompt new restrictions on economic activity and another sharp slowdown after the strong Q3 GDP rebound.
Strong Growth Rebound in Q3 2020
The global economy posted a strong GDP growth rebound in Q3, with the US up 33% (annualized rate), the Eurozone up 61%, the UK expected to grow 82% and Japan on track to post a relatively more modest increase of 15%. US Q3 GDP grew at the fastest pace in the post-war period, after the record decline of -31.4% in Q2. The Q3 rebound was led by strong contributions from consumption spending, business equipment investment and residential investment. Consumption spending, which surged +41%, added over 25% to Q3 growth. Despite the strong Q3 gains, consumption spending in the US is still -2.5% below its pre-pandemic level. Among other GDP components, business equipment investment rebounded 70%, and housing investment rose 59%. These two components combined with goods consumption are traditionally most sensitive to interest rates.
The Eurozone also posted a strong rebound, with Q3 GDP surging 61.3% annualized, well above expectations, after the record -40% plunge in Q2. Full details on growth composition are not yet available, but the rebound was across the board, with GDP growth above expectations in Germany (+37%), France (+95%), Spain (+71%), Italy (+65%) and Portugal (+64%).
While the rebound from the COVID-triggered recession has been faster and stronger than expected in the US, the Eurozone, the UK and several Emerging Markets, the pace of growth is on track to slow as the initial fiscal stimulus fades and as the fresh wave of infections triggers renewed lockdowns. QMA Portfolio Manager Ed Keon, Robert Tipp, chief investment strategist at PGIM Fixed Income, and Ellen Gaske, senior economist at PGIM Fixed Income, all agreed that the pace of growth is decelerating from Q3's torrid and unsustainable pace. Gaske expects the US labor market to steadily improve, though the pace of job growth is moderating from the monthly job gains of more than 5 million during the summer. Looking ahead to Q4, current expectations are for US growth to moderate into the 3%-to-5% range, due to the US Congress's failure to agree to new fiscal stimulus before the election, reduced odds of a big stimulus after the election, and renewed lockdowns in the wake of a new wave of infections. In the Eurozone, growth is expected to slow sharply after the Q3 rebound as governments initiate a new round of lockdowns with the surge in infections. Paolo Mazzocca, an analyst at Pramerica Italy SGR, pointed out that Eurozone confidence indicators are worsening rapidly, with the governments instituting new measures to limit mobility to combat the surge in COVID-19 cases. Mazzocca also highlighted the K-shaped recovery in confidence and activity among Eurozone countries and sectors, with strength in manufacturing PMIs and weakness in services PMIs and strength in Germany, while Italy, France and Spain, which have more services-oriented economies, are likely to struggle. The Eurozone is at risk of growth turning negative in Q4.
The outlook for Emerging Markets growth remains mixed. The northeast Asian economies have recovered and the rest of Asia is in the process of recovering, while growth in some Latin American countries and Europe, the Middle East and Africa remains weak. Rising COVID-19 infections are leading to fresh restrictions and growth downgrades, adding to near-term uncertainty.
Policy Support Underpins the Recovery
The global economic recovery continues to be underpinned by central banks' policy support rather than fiscal stimulus. In the US, hopes for a fiscal stimulus package before the election were dashed as the Republicans and Democrats could not come to an agreement. Markets were hoping for a big stimulus package after the elections in the event Biden won and Democrats took control of the Senate. However, with divided government looking more probable, a large stimulus package is unlikely because of resistance from Senate Republicans.
However, on the central bank side, many of the major central banks in Europe, the UK, Canada and Australia continue to undertake fresh easing measures. The central bank support and modest economic growth is expected to keep bond yields low. Tipp expects the US 10-year Treasury yield to trade in a range between 50 basis points (bps) and100 bps with a central tendency around 75 bps. The low interest rate backdrop is positive for risk assets, like equities and spread products, according to Tipp.
In the US, the Fed left policy unchanged at its early November meeting, but policymakers indicated they remain concerned about the impact of the fresh wave of infections as it "poses considerable risks to the economic outlook over the medium-term." Gaske pointed out that the Fed is likely to continue purchases at the current pace of $80 billion of Treasuries and $40 billion of mortgages per month, as the resurgence of private sector activity is reducing the need for more stimulus.
The European Central Bank (ECB), at its late October meeting, delivered a clear and strong signal of further easing in December. ECB President Lagarde and the Governing Council effectively made a pre-commitment to provide fresh stimulus in December, expanding the €1.350-billion Pandemic Emergency Purchase Program by € 500 billion in new purchases of corporate and government debt.
In the UK, the Bank of England announced additional stimulus measures in early November, including increasing the size of its UK government bond purchases by a bigger-than-expected £150 billion in response to the weakening UK outlook. The central bank now expects a renewed contraction in Q4 amid a virus second wave and lockdown.
Emerging market (EM) central banks have cut rates sharply, reduced reserve requirements for banks and have undertaken unconventional policy measures to support growth amidst the COVID-19 crisis. Around 20 emerging market central banks have undertaken some sort of quantitative easing program to address bond market dislocations. EM governments have also provided fiscal stimulus (about 3% of GDP) to support growth amidst the global lockdowns put in place to contain the spread of the virus.
COVID-19 Cases Surge
Over the past month, the onset of colder temperatures across the Northern Hemisphere has unleashed a new wave of COVID-19 cases, with worldwide daily new cases hovering in the 400,000 to 575,000 range in recent weeks. Europe and the US have been hit hardest in this wave. However, warm-weather areas, including India, Latin America, and the southern and southwestern US, have not seen cases disappear. In fact, cases are still rising strongly on an absolute basis, just at a slower pace than during the second wave over the summer.
In Europe— ground zero of the current wave—the number of daily new infections has reached nearly 140,000 in the Eurozone. While the cases were heavily concentrated in France and Spain a month or two ago, the numbers in Germany and Italy have risen dramatically recently. Consequently, governments are imposing new lockdowns to contain the spread of the virus. France, Germany, and Belgium are all under full national lockdown, while Italy and Spain have more limited lockdowns.
Even Sweden, which had infamously kept its country open during the first wave, has advised residents of major cities to stop throwing parties and to avoid places where the disease can easily spread. The UK went into a full lockdown on Thursday, with all pubs shut. In the US, individual states, rather than the federal government, are responsible for imposing lockdowns and other restrictions. Due to the timing of the presidential election and the politically charged atmosphere, no major lockdowns have been imposed. In India, the number of new COVID cases continues to trend lower, according to Srinivas Ravoori, equity chief investment officer, at PGIM India.
However, despite COVID-19 cases spiking higher, more people are surviving the disease than in the initial wave. The fatality rate has fallen to below 1% level from above 7% during the first wave in the spring as doctors have become better able to treat the infection, as the number of young people contracting the virus has increased, and as widespread availability of testing has enabled detection of more asymptomatic cases. The other major piece of good news, of course, is the announcement by Pfizer/ BioNTech that clinical trials of its vaccine candidate reveal the vaccine has been 90% effective in preventing COVID-19 infection.
Earnings Looking Good
The US Q3 earnings season is currently underway with earnings reports much better than expected. Earnings growth for the quarter are tracking at -10.2% year over year, much better than -25% year-over-year decline expected and the -30.6% decline in Q2. Earnings for Eurozone companies are expected to decline a sharp -38.4% in 2021 before rebounding +52.7% in 2021, while Japanese earnings are set to decline a modest -9.7% in 2020 before rising around 43.8% in 2021. EM earnings are on track to decline -11.3% in 2020.
The Bottom Line
Equity markets started November on a strong note, after struggling in September and October, on hopes for a large fiscal stimulus package post-US election. However, with expectations of a Blue Wave fizzling, the market rally went into overdrive on prospects for a divided US government.
The November CIO Call participants discussed the lingering uncertainty related to the US election and the setback to the recovery from the fresh wave of infection sweeping across Europe and US. The risk of a protracted legal fight over the outcome of the US presidential election is likely to be offset by optimism about prospects for a divided government, which reduces the odds of tax hikes and increased regulation under a Biden administration.
Further, while the fresh wave of COVID infection raises risks to the economic recovery, continued policy support, especially from central banks, and potential fiscal stimulus should cushion the slowdown. In addition, improved treatment and early detection has reduced COVID-19 mortality rates, while an effective vaccine is likely to be approved and available in a few months, which should improve risk appetite further. Finally, the low interest rate backdrop continues to be a tailwind for stocks and other risk assets. Consequently, the November Call participants remained positive on the outlook for markets and expect stocks and other risk assets to post further gains.