A Healthy Correction For Unhealthy Reasons

Jay PowellFOMC Chair Powell answers reporters questions at the March 3, 2020 press conference

Yves Bonzon (Julius Baer) | The global equity market has seen a multi-percent- age correction for a variety of reasons, from re- newed fears of a second wave of coronavirus infec- tions to disappointment about Federal Reserve (Fed) Chairman Jerome Powell’s policy stance. In the wake of a rally of almost 50% from the lows of March, it is fair to say that such a decline cannot come as a surprise. In fact, the complacency of the market about the multitude of small but negative factors has been the subject of my weekly updates for some time. From a technical point of view, it is a pause that will make the long-term trend more sta- ble and is welcomed as such, even though the mar- ket fears of a second wave are an unpleasant topic.


With the Fed holding rates at zero for a very long period of time, there is no alternative to diversified investments. Powell’s presentation of the economic outlook is often cited as a catalyst for the recent correction of the equity market. Admittedly, he has not moved towards explicitly controlling the yield curve. However, he promised to raise interest rates only after full employment is restored, which could take several years. Holding cash will not be re- warded for a very long period of time, and I strongly reiterate the call to view the asset allocation, and not cash, as the true benchmark in a world of ex- plicit financial repression. As such, Powell’s state- ment is constructive for financial markets, and we therefore stick to our current stance on equities.


The outlook for lower rates for longer is not only supportive from a valuation perspective, but also means that an enormous amount of money parked in money market funds could be channelled back into higher-yielding instruments. In the first weeks of the coronavirus crisis, US money market funds recorded an inflow of more than USD 1 trillion to a peak volume of USD 4.8 trillion. Inflows were higher and more rapid than during the Great Financial Cri- sis. Given the outlook for a prolonged zero-inter- est-rate environment, as mentioned above, and with the global economy stabilising, money will exit these short-term funds and flow back into equities and bonds.

The flow impact on the market can be best de- scribed as the ‘espresso cup phenomenon’. If you add the same amount of milk to an espresso and to a normal coffee, the former shows a bigger increase in volume. The same can be observed on the bond markets. For the huge money market funds, the outflow of USD 70 billion over two weeks is benign. For the riskier segments of the bond market, such as US high-yield bonds and emerging market bonds, however, even a fraction of this money can lead to considerable upward pressure on prices. Our fund specialists have captured this momentum in recent weeks and we maintain our positions in anticipation of more liquidity-driven gains, despite the negative news flow about infection rates in Latin America.

Latin America is becoming the new focus point of the coronavirus crisis. Chile has registered an ac- celeration of official infection rates to 0.9% of the population, higher than the US (0.6%), Spain (0.5%) or Italy (0.4%). In contrast to Europe and Asia, infection rates are accelerating in Latin Amer- ica, with no sign of stabilisation. The timid rebound in commodity prices and world trade cannot com- pensate for the collapse in private demand, and governments lack the capacity for meaningful fiscal support measures. We continue to focus our invest- ment strategy exclusively on Asian equity markets and are currently not viewing the Latin American markets as attractive given the economic malaise.

The hunger for daily economic data is insatiable, and new weekly and daily trackers are created and published almost on a daily basis. In essence, they tell us what we knew from the very beginning: the lockdown measures brought the economy to a standstill at the end of the first quarter, and the re- opening allows a recovery in private consumption, production and travel activities in the current quar- ter. We do not know how reliable the data are, due to the lack of history. With this in mind, it is our aim to incorporate all available information in our in- vestment decisions. Regarding the eurozone, the message is that the German economy has coped with the lockdown better than France, Italy or Spain. The eurozone’s biggest economy is also exit- ing the recession with greater momentum. The stronger the German recovery, however, the less pressure Berlin might feel to contribute to an eco- nomic stimulus package for the entire eurozone. The stress for the European Monetary Union will thus not end with this week’s European Union sum- mit.


Banks are part of the solution to the coronavirus crisis, not part of the problem, as we argued early on in the crisis. Government guarantees for loans to cash-deprived companies have emerged as one of the most crucial tools to support the economies during the coronavirus lockdown – and only the banks have the network to distribute. After the first period of heightened activism, some policymakers have begun to argue that banks will generate risk- free profits while governments take the risk of a loan and the European Central Bank refinances it at -1%. In this context, some members of the Euro- pean Parliament have called for an explicit ban on dividend payments, payments of coupons on addi- tional tier-1 (AT1) debt and variable compensation, i.e. bonuses.

We note a growing level of government interven- tion in the economy during the crisis and in the reo- pening. The targeted support of selected compa- nies and industries contradicts our understanding of an open economy. That said, we are confident that common sense will rule against the direct in- terference into bank remuneration policies and the discretionary ban on paying investors for the risk they are bearing. In that sense, we expect eurozone banks to pay the coupons on AT1 debt and to re- sume dividend payments after 1 October 2020.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.