It’s difficult to know what to make of the economy and outlook for markets this time, and the feeling was summed up in a recent KKR note titled “The Twilight Zone”.
KKR notes that “the first quarter of 2020 will go down in history as the highest-velocity market drawdown”. To highlight the severity with which markets reacted, the global financial crisis saw a peak-to-trough drawdown over 322 days, but the covid-19 crisis troughed in around three weeks.
While markets have bounced back somewhat, there remain a number of uncertainties that may contribute to KKR’s thoughts that we may be in a twilight zone, rather than in the recovery phase.
“Investors must remember that everything is relative and nothing is as it seems. While disconcerting, that is also where we believe the opportunity set lies,” KKR added.
It is notable that many markets have staged major rallies, but macro-economic trends do not look so bright. Germany has just reported a 10 percent economic contraction in Q2, one of the sharpest on record in Europe’s economy. We can expect to see even worse figures in other countries in the not-too-distant future.
Unemployment is rising too and may go even higher as governments start to withdraw their generous support packages. The UK’s government is set to start asking employers to contribute to staff furlough schemes from the beginning of August, which prompted a string of job cut announcements at the beginning of July. Many businesses, particularly in air travel, hospitality and the already struggling retail sector are expected to continue to cut jobs as the year wears.
But there is a surprising amount of positivity out there as well. Reports suggest UK retail sales rebounded rapidly as shops began to reopen, climbing almost to the levels seen prior to covid-19 restrictions. Governments were also very quick to announce stimulus packages to help with disruption caused by the virus and appear to be keen to keep investing in their economies with infrastructure packages and more. There remains significant talk of a V-shaped recovery.
This is where the challenge for investors in credit markets will come from. Judging which parts of the economy will perform well, particularly in the long term, will be what singles out the best fund managers from the rest of the pack. It will also be important to understand which businesses are only on life support from the government (AKA zombie companies) and which ones can actually live without government support.
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