Chief strategist: Flames dampened, but embers still smouldering

Danske Bank’s strategists take stock of the financial markets after the first five weeks of the corona crisis – and they see more upside than downside in equity markets right now.

The worst of the firefighting is over, but the embers may continue to smoulder for some time yet. That’s how chief strategist Henrik Drusebjerg describes the situation in the financial markets, where the corona crisis has now entered its sixth week. Equity markets actually rose quite significantly overall in the past week, after the very pronounced declines of previous weeks.

“The huge economic assistance packages from governments and central banks around the world have dampened investor fears and panic selling, plus the increases are also a natural counter-reaction to a period of steep price falls. One reason for this is that many institutional investors have been buying up equities to re-establish their target allocations of equities and bonds in their portfolios,” explains Henrik Drusebjerg.

Credit market thaw

Various indicators point to the worst turmoil being behind us, says the chief strategist – not least the credit markets, which include bonds issued by companies.

“Credit markets are vital to the flow of money and companies being able to raise new capital, and the past week has seen these markets thaw after being solidly frozen for several weeks, during which time investors had trouble trading bonds and companies struggled to raise new capital on reasonable terms. Lately, however, companies like McDonalds, Nike, Pfizer and Nestlé have been able to issue new bonds at sensible interest rates,” he says.

Escalating crisis averted

Central banks in Europe and the US have played a critical role in stabilising credit markets, says Henrik Drusebjerg, by announcing massive asset-purchase programmes – in the US without any defined ceiling. In addition, the US central bank, the Fed, announced last Monday it would buy up corporate bonds for the first time ever, averting an otherwise escalating credit crisis.

Italian government bond yields are another sign the worst panic is over, notes the chief strategist. After steep increases in the middle of March, yields have retreated again.

“Italy’s government will have to borrow a great deal of money to mitigate the negative economic effects of the coronavirus, so funding costs have perhaps never been more important. Hence, falling yields (or interest rates) are a positive sign – and a vote of confidence from investors in the European Central Bank, which has announced it will buy European government bonds, including Italian bonds,” says Henrik Drusebjerg.

Recovery in second half of 2020

Even though the financial markets have calmed somewhat, a long, hard struggle still awaits. The global economy is paralysed and will remain so for some time yet. For, while some European countries are probably close to peaking in terms of new coronavirus infections, the US is at an earlier stage and probably still has the worst to come.

“Metaphorically speaking, we still have a mountain in front of us, but there is an increasingly broad consensus that we will reach the top and be able to climb down again on the other side. Nevertheless, the coming weeks and months will pose a difficult balancing act, with politicians having to gradually open up the economy again without risking major new virus outbreaks. At Danske Bank, we still expect to see a recovery in global economic activity in the second half of 2020,” says Henrik Drusebjerg.

Investors in the dark

While the chief strategist assesses the worst equity price falls to be behind us, he still expects a great deal of uncertainty and significant market volatility in the time ahead.

“We are heading towards a period of pretty terrible economic numbers that strictly speaking will be largely useless for investors to navigate by, plus companies will likely be unable to make sensible pronouncements on their expectations for 2020. Hence, investors are groping in the dark somewhat at the moment and left to focus on other things, such as assessments of economic assistance packages and the number of infected, and further developments here could give pronounced market swings,” he says.

Right now, though, corporate earnings for 2020 are not the biggest worry for investors, but rather when the economy might pick up again and how great the consequences of the coronavirus might be for companies and the economy in the meantime.

Upside outweighs downside

Following the deep price falls in March, Henrik Drusebjerg generally sees greater upside potential than downside risk in equity markets right now – though further periods of sharply declining prices definitely cannot be ruled out.

“However, we should remember that experience indicates the turnaround in equity markets will materialise some time ahead of the turnaround in the economy once investors begin to see the first bright spots on the horizon,” he concludes.