Research and Market Commentary

What the latest COVID-19 developments mean for global markets

March 28, 2020

 

 

The COVID-19 outbreak has sent economic shockwaves across the globe as consumers retreat to their homes in a co-ordinated effort to slow the spread of the coronavirus.

 

The implications of suspended consumption and production are vast for multiple sectors of the Canadian and global economies, and developments are changing rapidly.

 

 

We asked Scotiabank analysts to weigh in on what COVID-19 means for currencies, equities, retail and energy right now.

 

Foreign Exchange

  • The USD has weakened significantly this week so far and fell by the most in one day (-1.75% against its major currency peers) since 2015 on Thursday, following the release of the US weekly jobless claims data which showed a record 3.3 million people filed for unemployment insurance in the week through March 24.  Markets are less focused on the economic data, however, than the broad and significant fiscal and monetary policy measures being implemented by the US authorities to offset the economic hiatus caused by the shutdown of the US economy in response to the coronavirus outbreak. 

 

  • Unprecedented global monetary and fiscal stimulus has helped steady the equity markets – and prompt a significant rally in the major US indices this week – while the Fed’s promise of “unlimited” quantitative easing (QE) and other measures to prop up markets and foster growth promises a deluge of USD liquidity surging into the markets in the coming weeks and months.  In particular, the expansion of the Fed’s swap lines with other, major central banks around the world has eased the severe tightness in the offshore dollar funding markets and reduced upward pressure on the USD.  More generally, the promise of the Fed’s significant monetary firepower through asset purchases suggests to us that the increase of USD liquidity in global markets implicit in this move will weigh on the USD, as was the case following the Fed’s first QE measures following the financial crisis in 2008.

 

  • The CAD remains soft but has recovered well from last week’s low against the USD just under 1.47.  USDCAD slipped back to just below 1.40 this week.  We think the CAD could edge a little higher still in the short run, given the general softness of the USD.  But while crude oil prices remain depressed, there is little chance of a sustained pick-up in the CAD.  Nevertheless, the immediate risk of a further CAD slide towards 1.50 or more seems to have been reduced significantly now and we expect USD rebounds will be met with solid supply back to the 1.44/1.45 range in the near term. 

 

—  Shaun Osborne, Managing Director, Chief FX Strategist, and Juan Manuel Herrera, FX Strategist

 

Global Equities

  • Temporary reprieve: Equities have rebounded sharply in the last three days, with the S&P 500 and TSX bouncing 20% from their respective lows. After such an acute and relentless decline in stock prices, our tactical indicators (Panic/Euphoria Index, Risk-on/Risk-off barometer, among others) were all extremely stretched, pointing to an imminent rebound in risk-appetite.

 

  • Quarter-end rebalancing to the rescue: Moreover, equities have underperformed other asset classes so badly in the last month that money managers have to add to their equity allocation in order to meet minimum weights. Rebalancing into quarter-end could very well keep equities afloat for the next week or so.

 

  • Waiting for the US COVID-19 second derivative: Still, we also indicated that any lasting equity bounce will depend on the virus contagion rate peaking, especially in the US. It is this “2nd derivative trade” in COVID cases or “rate-of-change” metric that we believe has stabilized equity markets in China, Korea and Italy. While the US equity market appears to be finding its footing, there is only one direction on US COVID -19 cases, i.e., we’re not yet seeing that inflection point, which is leading us to believe that the “all clear” sign is not yet flashing. Hard to tell if equities have made “a low” or “the low” earlier this week, but we would not be surprised to see a retest in April or May.  

 

  • Steep earnings contraction not fully priced in: While the outlook remains murky, it seems unlikely that earnings will escape unscathed this year. We recently reduced our 2020 EPS forecasts, expecting a 6% contraction in the US and 17% decline in Canada. While consensus has started to come down, it continues to bank on mild EPS growth, which won’t happen. 

 

  • Longer term: We believe the massive round of fiscal and monetary easing around the world should help activity levels/earnings to recover in 2021.

 

—  Hugo Ste-Marie, Director Portfolio & Quantitative Strategy; Jean-Michel Gauthier, Associate Director, Portfolio & Quantitative Strategy; and Simone Arel, Research Associate, Global Equity Research

 

Retail

  • We noted last week that the combined impact of COVID-19 and plummeting oil prices would have a profound impact on Canadian retailers, and that is certainly proving to be the case. The situation calls for extreme degrees of flexibility as each day brings new challenges. Perhaps the most difficult is trying to anticipate what is going to change next and how to get out in front of it and adapt communications and operating practices. This is being done at the same time as companies are dealing with either seriously dampened demand and store closures in the case of some, or heightened demand that is taxing the supply chain for those that provide essential services like food and grocery products, pharmaceuticals and fuel.

 

  • Companies like Sobeys, Metro, Loblaw, Dollarama and Canadian Tire, whose workers are very much in the front line of the COVID-19 crisis, have stepped up and are offering their employees higher wages. Before the onset of COVID-19, one of the biggest challenges for Canadian retailers was very tight labour markets. How that has changed! Combined, COVID-19 and plummeting oil have made an unprecedented number of Canadians jobless. Companies selling essential goods are actively reaching out to laid-off workers in other sectors.

 

  • Non-essential retailers have been forced to close stores for an indefinite period. In the absence of associated revenue, many have taken the right decision to continue to pay their employees, which means an added burden on the P&L. While some retailers cannot expect a meaningful shift to simply shopping online, some categories are seeing enhanced online demand. Canadians are spending more time at home and more time with their children as schools have closed across the country. This means more at-home activities such as baking, crafting and home projects and a rise in online sales of related products.

 

  • We see a number of likely changes to come from COVID-19 that will impact these companies longer term. First, we believe COVID-19 will accelerate online retail in this country, particularly in the grocery sector. Second, given the profound impact COVID-19 is having on the nation’s healthcare sector, it could act as a catalyst for provinces to extend the scope of services and activities permitted by pharmacists and pharmacies, lowering the burden on the overall system. And third we believe Canadian consumers may view companies and brands differently post COVID-19 based on the approaches taken to deal with the crisis. We anticipate an affinity for those companies that were seen doing the right thing throughout the crisis, not only for customers but for employees and the disadvantaged.

 

  • From an investment perspective, we are seeing far too many companies’ shares trading at unprecedented levels, and we are seeing very interesting value creation. While we still face much uncertainty with respect to the duration of these challenges and the degree to which earnings will be impacted, we believe companies with strong management teams, good brands, solid balance sheets, and sound strategies will emerge well-positioned.

 

—  Patricia Baker, Director, Retailing, Global Equity Research

 

Energy

  • The $2 trillion U.S. stimulus package may go a long way to aid individual households and businesses that have been impacted by COVID-19, but it will take a number of months, possibly quarters, to see economic activity fully restored. Even if demand resumes to normal levels, the oil market remains woefully over-supplied due to an evolving price-war between Saudi Arabia and Russia. Positively, regions that were hit first by the virus, such as China and South Korea, are showing noticeable signs of recovery and data suggests increasing economic activity. We believe this global pandemic is temporary, but no one knows when it’ll all be over.

 

  • Oil market fundamentals went from bad to much worse when Saudi Arabia signalled its intentions to slash its official selling price and ramp up production in retaliation for Russia balking from necessary OPEC+ supply cuts. We are expecting significantly more supply from Saudi Arabia, the U.A.E., and Iraq in the coming quarters in order to pressure Russia back to the OPEC+ negotiating table.

 

  • US shale supply is likely to head significantly lower. With WTI averaging above $57 per barrel in 2019, shale was already showing clears signs of slowing down. Legacy well decline rates were climbing faster than drilling activity, leaving little net growth into subsequent quarters. Now as oil prices reach into the low-$20’s per barrel range, far below break-even level, we expect investment to dry up and negative growth going forward.

 

—  Michael Loewen, Director, Commodities Strategist, Global Equity Research

 

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