Old risks fade, new risks emerge

Old risks fade, new risks emerge

May has been the month when investment and economic reality diverged. The global economic contraction is deepening. Composite purchasing managers' indices, the most timely economic indicator, hit a record low globally in April. Preliminary estimates for May show a slightly slower rate of contraction, but the figures are still in deep negative territory.

GDP growth also contracted sharply in the first quarter. The drop was deepest in China, where the outbreak first began in January. Nevertheless, other major and developing economies are also in the red. Thailand saw its first year-on-year GDP decline in six years, reflecting the pandemic and subsequent lockdown, as well as other negative factors including the delayed budget and drought.

Despite the dire economic figures, the picture from the investment world is quite rosy. Stock markets -- barring some that face their own negative factors -- have risen by 1-3% in general. Rich-world bond yields, an indicator of risk aversion, have been roughly stagnant, especially in the US, Japan and Germany, while the VIX index that measures volatility has been inching lower.

The most noteworthy asset class has been oil, prices of which have skyrocketed in May after a spectacular drop in April to negative territory. This month, prices have risen 65% for West Texas Intermediate and 83% for Brent crude.

SCB Securities sees three factors behind the recovery of risk asset prices in May:

1. Continued monetary stimulus. As this column has noted frequently, the more liquidity injected by central banks, the greater the rise in risk asset prices, since liquidity plays a vital role in shoring up risk assets, even when the future economic and business outlook is weak.

In April, the balance sheets for the four major central banks (the US, Europe, Japan and England) increased by a record $1.8 trillion. The US Federal Reserve's balance sheet now stands at $7 trillion, up from $4.1 trillion two months ago.

The announcement of a flurry of stimulus measures, including purchases of corporate bonds, has meaningfully improved liquidity in the credit market, while credit spreads have narrowed substantially.

Investors also got a renewed confidence boost from Fed chairman Jerome Powell, who reiterated that the central bank has not exhausted its options to support the US economy, even after the unprecedented steps it has already taken over the past two months.

2. Reopening progress. Recently, countries that have seen reductions in active Covid-19 cases and declines in new cases have started the process of carefully reopening their economies.

This progress can be measured by the Oxford University Stringency Index, which has been tracking government responses based on 17 indicators in three categories: containment policies such as social distancing and business closures; economic policies such as income support; and health system policies such as testing.

In most countries there has been a gradual drop in the stringency indices. Regionally, one exception is Singapore, where new infection rates remain high among migrant labourers. In the US, all 50 states have now begun reopening, and a revival of economic activity is under way.

3. Vaccine development. Researchers and companies in several countries have been rushing to produce a Covid-19 vaccine, with some early successes reported, while the regulatory approval process has been sped up. This has given a positive boost to the market.

The most recent hopeful news on the vaccine front is from the US biotech firm Moderna, which said Phase 1 clinical trials of its mRNA-1273 showed positive results. Eight people treated with the vaccine developed the same levels of antibodies as is found in people who have recovered from Covid-19.

Moderna plans Phase 3 trials in July and says the vaccine could be in widespread use by the end of 2020 or early 2021.

Other promising results were reported earlier for remdesivir, an antiviral made by US-based Gilead Sciences. It has been shown to speed up recovery times for Covid-19 patients in a major US-led trial.

Other companies, including J&J, Inovio and AstraZeneca, are rushing towards a vaccine and/or drug treatments as well.


Despite the rosier outlook, we believe a new risk is evolving and may become the biggest headwind to economic health and investment going forward. We're talking about a cold war between the two largest economies in the world.

The US administration has been accusing its Chinese counterpart of mismanaging the earliest stages of the virus outbreak, leading to a devastating global pandemic that might have been avoided.

On the trade front, Washington is accusing Beijing of not keeping the promises it made to import certain US products as stated in the countries' Phase 1 trade deal.

But even as China started to import more US agricultural products, Washington renewed the ban on Huawei and ZTE, the two biggest Chinese tech companies, for another year.

Meanwhile, the US Senate has passed a law to require Chinese companies to follow US accounting standards, or certify that they are not owned by a foreign government; otherwise, they could be banned from listing on a US stock exchange.

It is logical to think that the current spat will not escalate to the point where it hurts the world economy or financial markets, especially at a time of crisis. But the Trump administration is never short of surprises, and one might expect even more in an election year.

Consequently, we recommend that investors be extremely cautious. Focus on good-quality assets with strong balance sheets and for which the negative impact from the pandemic and the cold war will be minimal. We also maintain our recommendation for high-quality private corporate bonds, infrastructure funds, REITs and gold.

Extreme caution and diversification should be foremost in investors' minds in this extraordinary year.

Piyasak Manason is senior vice-president and head of the wealth research department at SCB Securities, email piyasak.manason@scb.co.th

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