COVID-19 SPECIAL: Commentary

Reopening is good news for stocks

There is reason to stay risk-on despite danger of 2nd wave of Covid-19, US-China tensions

Global risk assets have enjoyed a solid rally since bottoming out in March, Asian equities are up by almost 20 per cent, the S&P 500 has climbed 32 per cent, oil prices are on the rise and credit markets are recovering.

Yet, economic data remains grim. The global economy is set to contract by 3.3 per cent this year, with Singapore's gross domestic product (GDP) forecast to shrink by 7.3 per cent, in our view.

In the United States, the unemployment rate is now 13.3 per cent, almost the highest on record and way up from just 3.5 per cent two months ago, while corporate bankruptcies in April surged the most in a single month.

So, how can it be that markets are recovering so quickly while the world's economies are suffering?

This disconnect is a reminder that markets are forward-looking, and already looking past the near-term crunch to the rebound ahead. And, indeed, global economic growth and earnings should bottom out this quarter as Covid-19 restrictions ease.

So, despite second-wave risks and intensifying US-China strains, there's reason to stay risk-on.

EXIT FROM LOCKDOWN BEGINS

All of North Asia has withdrawn from its strict quarantine measures. China, being the first to face the coronavirus, is now leading the world in getting a measure of control over it. Key activity readings such as industrial production and fixed investments are back above pre-pandemic levels, and consumption indicators are improving.

Other markets in Asia and Europe are reopening in phases, and the US is quickly lifting stay-home orders across the country. Economic indicators are turning sharply up worldwide, although they remain at very low levels.

Meanwhile, to contain the damage to jobs and private-sector balance sheets, the extraordinary policy response continues.

The US is mulling over another US$1 trillion (S$1.4 trillion) in fiscal support. At China's recently concluded annual meeting of the National People's Congress (NPC), while GDP targets weren't offered, the government raised monetary targets and expanded the augmented fiscal deficit by 550 basis points to more than 15 per cent of GDP.

And in Singapore, about $92.5 billion in fiscal spending has been earmarked to cushion the pandemic fallout.

How sustainably markets perform from here will depend on how successfully economies exit from their lockdowns. This puts the focus on whether a second wave or second wind will emerge from the worldwide reopening effort.

Young women in traditional dress at The Bund in Shanghai last Tuesday. China, being the first to face Covid-19, is now leading the world in getting a measure of control over it. Other markets in Asia and Europe are reopening in phases, and economic i
Young women in traditional dress at The Bund in Shanghai last Tuesday. China, being the first to face Covid-19, is now leading the world in getting a measure of control over it. Other markets in Asia and Europe are reopening in phases, and economic indicators are turning sharply up worldwide, although they remain at very low levels. PHOTO: AGENCE FRANCE-PRESSE

SECOND WAVE OR SECOND WIND?

The experience of past pandemics has led some to caution that a second wave of infections that is worse than the first may strike late this year.

There have been minor outbreaks of new cases in South Korea and China after both reopened, but they were swiftly contained. Germany, Austria and several US states are also faring better than feared.

Still, a second wave that forces renewed shutdowns is a tail risk that needs to be monitored, especially as winter approaches in the Northern Hemisphere.

In the meantime, a "second wind" to markets could emerge if confidence grows that a second wave can be managed.

Here, the key thing to watch is vaccine progress, the advancement of which could offer a path towards a sustainable return to economic normalisation. Gilead's remdesivir and Moderna's vaccine trial are two potential drug treatments that are receiving fast-tracked approval to trial and manufacture.

This second wind would help unlock value that has been suppressed in sectors most affected by the lockdown, including small caps, value and cyclical markets.

GEOPOLITICAL TENSIONS NOT THE ONLY STORY

Amid news of Beijing's planned national security law for Hong Kong, another key risk is rapidly unfolding: the rising tensions between China and the US.

According to the Pew Research Centre, a record 66 per cent of Americans now hold a negative view of China. With its presidential election about five months away, the US is set to remain on the offensive.

That said, both countries will likely eschew a tariff escalation and extreme moves that could undercut their recoveries.

So far, the slew of measures adopted by the US have mostly had more bark than bite as there are ways to work around them.

Take the Senate Bill that could result in the delisting of Chinese ADRs (American depositary receipts) from US stock exchanges. If this were to take effect, the process would likely be drawn out over years and would simply result in more secondary listings in Hong Kong or Shanghai.

The new restrictions on Huawei may hurt the share prices of the companies in its supply chain, but they also reinforce China's plan to speed up investments in critical technologies.

Moreover, while China is behind in its phase one targets, indications suggest that it may still fulfil its obligations. Encouragingly, Beijing reiterated at the NPC meeting that it remains committed to keeping its phase one agreements.

While the long-term decoupling of the United States and China has been set in motion, an abrupt end to interdependencies remains highly unlikely. For now, the reopening story alongside the policy pulse will likely be the bigger driver for markets.

INVESTING IN ASIA'S REOPENING

Asian stocks are likely to post flat earnings this year, in our view, compared with a near 20 per cent decline globally, yet they're trading at a near 36 per cent discount to global benchmarks.

As restrictions ease, Asian markets should benefit - Chinese and Singapore equities are most preferred, while Hong Kong and Thai equities are least preferred.

The immediate beneficiaries of Asia's reopening will likely be consumption recovery plays, such as regional autos, consumer electronics, transportation and select casinos.

For the medium term, affordable growth stocks such as leading technology platforms and quality cyclicals in the insurance and banking industries look attractive at current valuations.

Further out, themes like China's intelligent infrastructure and Asean's new economy should get a boost from the Covid-19 pandemic.

Automation and robotics should benefit from increased reshoring, while e-commerce, fintech and healthcare, which spans genetic therapies, oncology and telemedicine, should continue to see upside long after the current crisis is over.

The writer is Asia-Pacific head of UBS Global Wealth Management's chief investment office.

Join ST's Telegram channel and get the latest breaking news delivered to you.

A version of this article appeared in the print edition of The Straits Times on June 08, 2020, with the headline Reopening is good news for stocks. Subscribe