Investment scenarios in the second half of 2020 will be shaped by some key structural and cyclical themes. Scientists around the world are racing against time to overcome the overwhelming Covid-19 related hurdles that stand between us and the full re-opening of economies worldwide.
Globally, there is still a lack of clarity over the depth of the slump and the speed of the recovery. US-China tensions remain in sharp focus, amid rising political temperature ahead of the US elections and deteriorating US public sentiment on China.
Mindful of the risks to the nascent global economic recovery, central banks and governments have signalled their determination to provide continued support through ultra-loose monetary policy and further fiscal stimulus. With interest rates likely to remain persistently low, we continue see opportunities in selected risky assets, especially beneficiaries of structural forces set off by the pandemic such as the increase in online consumption and a sharper focus on long term sustainability risks for businesses and society.
Theme 1: US-China: The Great Decoupling
Even as the global economy continues to grapple with the aftershocks of Covid-19, USChina tensions remain in sharp focus amid rising political temperature ahead of the US elections in November. US public sentiment on China has continued to deteriorate and we expect that intensifying aggression against China would be a key component of President Trump’s re-election campaign strategy (Exhibit 1).
Exhibit 1: US public sentiment on China at a low
Source: Pew Research Center survey results, published 21 April 2020
As we enter the second half of the year, both countries continue to spar verbally and engage in tit-for-tat actions, including visa bans on blacklisted officials.
The latest series of escalations is particularly worrying as it has rapidly expanded to encompass a wide range of issues including trade, technology, capital markets and investments, healthcare and geopolitics against a backdrop of a still-weak global economic outlook, raising concerns about the impact on the nascent recovery in the world economy and the longer term reshaping of global supply chains.
In particular, the race towards being a leader in 5G technologies, which will underpin the global digital economy, is a major component of the major trust deficit between the two superpowers.
Tensions in the technology arena continue to escalate. Huawei is China’s 5G champion and is the focal point of US mistrust given long-standing allegations of security issues.
Recent rule changes announced by the US Bureau of Industry and Security (BIS) in May this year will effectively restrict Huawei’s ability to use US software and technology to design and manufacture its semiconductors.
This move poses a potential near-term risk to China’s 5G rollout, given Huawei’s substantial share of China’s 5G base stations. This would have far-reaching implications on the broader technology complex.
US-China tensions have also rapidly spilled over to a wide-ranging set of issues such as the listing of ADRs of Chinese companies in the US and the allocation of US funds into Chinese investments.
If the Holding Foreign Companies Accountable Act is passed into law, we see this as a negative development over the long term as it could make new IPOs of Chinese ADRs more difficult, especially for unprofitable companies with a short operating history, and accelerate secondary listings of large-cap ADRs outside of the US.
President Trump is also exerting pressure on China in other areas of investments and funding, including directing the Federal Retirement Thrift Investment Board (FRTIB) to defer the implementation of a new, China-inclusive index for its international fund which was planned for early as June 1.
Finally, Hong Kong promises to be another sensitive issue ahead, in addition to other USChina geopolitical hot buttons such as the Covid-19 crisis, the World Health Organization, Taiwan and the South China Sea.
Theme 2: Race for the White House
Uncertainty related to the US presidential election in November is a clear source of potential market volatility over the next few months as the election draws nearer.
Key domestic issues likely to turn into political footballs include the scale and duration of additional fiscal support that would be needed to avert the upcoming US fiscal mini-cliffs.
Four emergency programmes totalling some USD1.5 trillion passed by Congress in Q2 2020 will be exhausted or expire by end-July. Another fiscal stimulus package is likely, but negotiations on this have only just begun after the Senate’s 4 July recess ended on 20 July and both sides will want to extract maximum political gain from the talks, as well as the timing and structure of the fiscal stimulus.
A November win by Democratic presidential contender Joe Biden with a Republican Senate and Democratic House would likely be the best scenario for markets over the long term, as we would see a more measured approach from the White House towards the US-China relationship while President Trump’s tax cuts are unlikely to be rolled back with a Republican Senate.
Following this, the next-best outcome for markets would be a Trump win.
Finally, we see a Democratic sweep of the White House and Congress to be the outcome most detrimental to markets given the likelihood of higher corporate and capital gains taxes.
Already, betting markets and polls at key states for the US presidential elections and at-risk Republican Senate seats are reflecting a rising probability of a scenario of a Democratic sweep.
Historically, the US presidential election comes into focus as a market driver in the second half of election years.
As we move through Q3 2020, rising odds of a feared Democratic sweep of the White House and Congress might prove to be a stumbling block for risk assets that have so far been supported by unprecedented stimulus from policymakers and optimism over the postpandemic economic rebound.
Entering 2H 2020, President Trump’s polling numbers have declined significantly amidst nationwide protests that started with the killing of George Floyd on 25 May 2020 (Exhibit 2).
Exhibit 2: President Trump’s polling numbers have declined amidst nationwide protests
Source: Real Clear Politics, latest data as at 1 July 2020
Under a Democratic presidency, the rapidly growing sectors around renewable and zerocarbon energy production and operation would see a new dawn. A Democratic President would emphasise large-scale emissions reduction, which would foster de-carbonisation through massive investment in clean energy infrastructure and deployment of low-carbon or even zero-carbon fuels in the US economy.
In the utilities sector in particular, we see increased bifurcation between those firms that are more exposed to renewables compared to those still living in the past.
A Democratic President would likely strengthen the National Environmental Policy Act to clarify the scope of climate and emissions reduction disclosure, and likely also provide greater support for renewables infrastructure such as offshore wind fields.
Any company that owns coal, nuclear or gas generation outside of a cost-of-service rate framework is at risk of losing market share and earnings. Should there be a carbon tax, companies with power fleets that are predominantly coal-and gas-fired would see their plants at risk of becoming uneconomic.
Theme 3: Unprecedented Stimulus – Opportunities and Risks
Over the past few months, policymakers across the world have unleashed wave after wave of fiscal and monetary stimulus to support their economies and cushion them from the worst effects of the Covid-19 pandemic.
As we move into the second half of the year, central banks across developed markets have signalled their determination to leave their liquidity taps fully open.
In the US, Federal Reserve policymakers have explicitly guided that they expect to keep interest rates at current near-zero levels until at least end-2022.
Given the uncertain path back to a full economic recovery, we expect the Fed to keep rates at near zero for up to the next five years (Exhibit 3), and to maintain a flexible stance towards asset purchases in an effort to ensure that rates at the long end of the US Treasury yield curve remain low.
Exhibit 3: Interest rates are likely to stay lower for longer
Source: Bloomberg, Bank of Singapore; as at 7 July 2020 Note: Shaded area shows Bank of Singapore projections
Over the course of this crisis, we have witnessed unprecedented fiscal stimulus from governments which will over the long term exert significantly higher debt levels and pressure on national budgets as policymakers spend on healthcare and a wide range of efforts to counteract the medical and economic shocks of the virus.
This will broadly result in higher fiscal deficits and upward pressure on tax rates. The issue of sustainability over the longer term will also be raised, particularly for countries with significant twin deficits and also for those that do not issue debt in their own currencies.
At the same time, global central banks have implemented monetary and credit stimulus that are unprecedented in terms of speed and size, and it will take some time for the long term market implications of these measures, which were necessary to restore confidence and forestall a larger financial crisis, to become clear.
Traditional economic theory would caution that excessive monetary easing and the blurring of fiscal and monetary policies towards debt monetization could result in risks of hyperinflation and debasement, although structural forces, such as demographics and technology continue to be countervailing forces that are anchoring inflation, and at least for the US there are no clear alternatives to the US dollar as the global reserve currency.
Going forward, we see major central banks keeping rates low to bolster the post-pandemic economic recovery and to escape the gravity of a lowflation trap.
Against this backdrop, we expect the hunt for yield to be an important driver of markets ahead, which underpins our constructive long-term view on emerging market high-yield bonds.
Theme 4: Emerging from a Pandemic
Almost every major crisis and recession in modern history has resulted in lasting implications for the investment landscape, and similarly the Covid-19 crisis will leave its permanent imprints. The pandemic will lead to changes in how economies function and establish new norms of economic activity and social interaction.
This will translate to more robust technology platforms for employees to work remotely, less concentration in terms of customer and supply chain risks, and stronger balance sheets with greater liquidity, longer term funding and reduced leverage.
For many companies, this also portends reduced dividend payouts, buybacks and capital expenditure, and more capital raising from investors.
As some poorly capitalized companies struggle to recover, we can also expect to see consolidation and restructuring in sectors that are badly affected by the virus outbreak.
Given the unprecedented demand and supply shocks in terms of speed, depth and breadth, many companies will come under pressure. Sectors facing concerns due to the pandemic broadly include those in hotels, gaming/casinos, retail and office real estate, energy, airlines, and autos.
The digitalisation of daily life – how people work and play – is here to stay, and we see a long runway in terms of growth for sectors such as in e-commerce, digital entertainment and leisure, and telehealth (Exhibit 4).
Exhibit 4: Sectoral winners from Covid-19 crisis.
Source: Bank of Singapore
At the same time, there will be sectors benefitting from the growth and acceptance of remote working and online channels due to the Covid19 outbreak. This will accelerate the “offline-toonline” phenomenon and strengthen industry trends such as remote office productivity, the rise of cloud business models, data centers, ecommerce, digital entertainment and leisure, and telehealth.
Exhibit 5: Covid-19 will leave lasting imprints on behavior
Source: Bank of Singapore
These structural forces, among others set off by the pandemic, will benefit selected players in the technology, communication services and healthcare sectors, as well as parts of the consumer sector.
Theme 5: ESG – Profit with Purpose
Recent deadly events have highlighted the need for increased action to guard against longterm sustainability risks for businesses and society as a whole. The Covid-19 pandemic sweeping across the world today has exposed the deepening inequality in wealth, living conditions and access to social security, healthcare and daily necessities even in developed economies.
The ensuing shutdown of large swathes of the global economy has also resulted in significant operational risks for companies. For many businesses, the integrity and resilience of their supply chains, and the quality of their employee relations and crisis management have suddenly come into sharp focus like never before.
We see the crisis accelerating emerging trends in ESG and we expect the heightened focus on businesses’ environmental and social impact to persist long after the crisis abates.
Risks to businesses from climate change are already rapidly materializing. Policy changes are introducing new regulatory risks for companies, especially those in sectors such as fossil fuel production (oil and gas, thermal coal), mining and power generation. Overall, we believe companies will face increasing regulatory, environmental, and consumer pressures associated with climate risk, forcing them to adapt or perish.
At the same time, the transition to a more environmentally friendly, climate-resilient global economy will introduce new opportunities for investment and growth. Companies that adapt successfully to this transition are increasingly likely to benefit from evolving consumer preferences and regulations and the reshaped economic landscape.
Sustainable funds in the United States set a record for flows in 1Q 2020, and estimated net flows for the 314 open-end and exchangetraded sustainable funds available to US investors reached USD10.5 billion in the first quarter, eclipsing the previous quarterly record set in 4Q 2019. Assets under management of ESG mandated funds have also continued to grow strongly (Exhibit 6).
Exhibit 6: Assets under management at ESG mandated funds, 2014-2020 year-to-date
Source: BlackRock Investment Institute, EPFR data as at June 2020. Note: Chart shows the global assets under management for ESG mandated funds. The “other" category includes money market and alternatives funds. Data for 2020 year-to-date is until 31 May 2020.
Climate change is not taking a break due to Covid-19 pandemic. Business and national leaders are pushing to “build back better” and promote green recoveries. As higher-quality ESG metrics and industry standards are developed and more ESG-focused products are introduced, we see increasingly greater opportunities for investors to align their portfolios more closely with their own sustainability preferences and goals.
There are a multitude of approaches to sustainable investing, and the investment approach ultimately needs to be aligned with investors’ goals and preferences – in the same way that investors’ risk appetite and long term financial goals should guide their optimal portfolio asset mix. Put simply, there is no one-size ESG approach that fits all investors and selecting the correct approach depends on proper identification of individual goals and preferences.
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Version: July 2020