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Europe Insights March 2020 update: 19.03.2020 Monthly update on European markets Europe: broad sweeping measures to stem the COVID-19 crisis The European governments have been scaling up their policy responses to combat the COVID-19 propagation (see figure 1). Spain and France have followed Italy in imposing a shutdown on their populations, and this for an initial period of 15 days. In Germany, the government has imposed among other measures, the closure of all non-essential shops, schools and day-care centers. Elsewhere in Europe, governments have gradually implemented social distancing measures, or are now considering drastic national shutdowns. Confinement measures to protect the health of the population will likely last more than one month. Although probably not available before next year, a vaccine, when announced, could dramatically restore business confidence. Uncertainties over the economic impact In the short term, the priority for the governments is to mitigate the impact of confinement and travel restrictions on businesses, which are now causing a massive supply-side shock on the economy. According to the European Commission (EC), the shock to the eurozone economy could lead to a GDP contraction in 2020, with a substantial but not complete rebound in 2021. For comparison, the 2008-2009 financial crisis led to a GDP loss (in real terms) of 4.5% in the eurozone, and the Euro debt crisis caused another shock, close to 1% GDP over 2012 and 2013. There will certainly be an economic contraction this year, and it will likely be deeper than the financial crisis. There are four key metrics that are likely to be important determining factors for the severity of the recession: How quickly and how widely COVID-19 spreads through major economies? How disruptive the containment measures taken by authorities are? Whether labour markets deteriorate substantially? and Whether financial systems will be compromised? Figure 1. Confirmed COVID-19 cases in selected countries From mid-March Covid-19 cases Start of confinement 30 000 or social distancing measures in 25 000 Spain, France, Germany, 20 000 US, UK 15 000 10 000 Italy: February 23th Started confinement 5 000 0 US Spain UK France Germany Greece South Korea Italy Source: Bloomberg - Data as of 16 March 2020 This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. Non contractual document. For Professional Clients and Institutional Investors Use Only.
Europe: broad sweeping measures to stem the COVID-19 crisis (contd.) Ramping up policy responses Despite the dramatic rise in the COVID-19 cases in Italy over the past three weeks, European governments have been acting very gradually. The first series of measures The policy responses came in Italy at the end of February, followed by Spain, France, the UK and the US. focus on helping The policy responses focus on helping firms to manage their financial liquidity positions. firms to manage their Announced measures so far have included state loan guarantees to businesses, and financial liquidity various support schemes for firms and employees (see Table 1). For instance in Spain, positions. firms will get loans from the state-owned ICO bank, similar to those put in place during On March 12th and the 2011-13 credit crunch. Also in Germany, the government has reactivated the 19th, the ECB reduced-hours subsidy scheme (Kurzarbeitergeld) until end-2020 - a scheme that was first experimented in the 2008-2009 crisis. unveiled a set of State loan guarantees and fiscal support will address firms and households’ liquidity additional easing risks. At the time of writing, the fiscal support as of % GDP is estimated between 0.5% measures, including (Germany) and 1.9% (France), not including state loan guarantees. Meanwhile, on a boost of its APP to March 12th and 19th, the European Central Bank (ECB) unveiled a set of additional its highest ever easing measures, including a boost of its Asset Purchase Program (APP) to its highest ever pace (see Data Watch p.4).The new Pandemic Emergency Purchase Program will allow bond purchase deviations in terms of size and flexibility in allocation over time. A minimum coordination at the European level Businesses and governments were not prepared for a pandemic and health emergency EU members agreed risk, so a policy coordination at the European Union level has proved impossible to emerge rapidly. to mobilize €37bn for The EU members, however, agreed to mobilize €37bn for the health crisis, under the the health crisis regional funding programs. The EC also announced that, given the severe economic downturn, European governments would be able to increase public spending, under the so-called flexibility clauses attached to the EU budget rules. Discussions are still under way for a coordinated EU-wide fiscal stimulus package. It remains to be seen whether, in this emergency health crisis, the EU governments will find a consensus around a new stabilization framework. In the aftermath of the 2010-2012 Eurozone debt crisis, the EU authorities set up the €500bn European Stability Mechanism (ESM), with emergency credit lines against a memorandum for stringent policy adjustment. The ESM is designed to rescue a few countries, not a whole region. Table 1. Policy measures announced by the governments Mobilized Country Policy Measures %GDP funds / costs • Loans available for all companies, mostly provided by KfW, the state development bank up to €550bn • Export credits and other guarantees for companies Germany • Corporate tax deferrals 0.5% • A government subsidised scheme for reduced-hours workers to avoid a peak in unemployment €8bn (E) • A regional fund launched in Bavaria to buy stakes in companies under stress €10bn • State guarantees for bank loans to businesses €300bn • Mechanism to compensate temporarily laid-off workers • Fiscal support to affected companies and employees France • Rescue package of companies with state shareholdings €45bn 1.9% • Deferrals of corporate tax and social security payments • "Sick leave" for workers who have to stay home to look after their children due to schools 'closures • Fiscal rescue package • Funds for the health system and the civil protection agency • €500 / person for the self-employed, fiscal support for companies paying redundancy payments, a Italy freeze on any worker lay-offs, and a cash bonus for Italians still working during the lockdown €25bn 1.4% • Moratorium on loan and mortgage payments • Financial support for families with children at home, taxi drivers and postal staff who continue to work • Financial support for national airline company • State loan guarantees €100bn • Initial package of measures including health spending €4bn Spain • Tax relief for SMEs and self-employed over 6 months €14bn 1.6% • Credit lines for the tourist sector and extended social security subsidies for seasonal workers €0.4bn Sweden • Support package KR300bn 6.2% • Loan guarantees to businesses £350bn UK • Fiscal support £20bn 0.9% Sources: European government websites as of 18 March 2020 – (E) Estimated The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC Global Asset Management. Consequently, HSBC Global Asset Management will not be held responsible for any investment or disinvestment decision taken on the basis of the commentary and/or analysis in this document. The content of this page is not intended as an advice or recommendation to buy or sell any sector or financial instrument. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target. Non contractual document. 2 For Professional Clients and Institutional Investors Use Only.
European Equity. What do valuations tell us about a market bottoming? At 18 March, the market was down 35.5% from the high in February. Only valuations can tell us how much further the market could go. Valuations have a floor even during the worst crisis and pandemics. A powerful valuation metric is the CAPE- Cyclically Adjusted Price to Earnings ratio created by Yale academic Robert Shiller. It Valuations have a floor helped to predict the dotcom crash, the 2008 crash and the 2018 downturn. Since 1872, even during the worst the Shiller PE for the US market has ranged from 5X in 1921 to 44X at the height of the crisis and pandemics. internet bubble. The four other recorded highs are 30X in 1929, 27X in 2008 and 33X in Based on 2009, the September 2018. The data for Europe available since 1935 ranges in a similar band from 6X to 40X. Shiller PE for the US and Europe could Fortunately, the European market is now quite cheap on this measure; 13X on 18 reach 13X and 10X March. Unfortunately, the US market is still expensive at 22.4X. This matters because a respectively, leaving further correction in the US market would surely continue to bring down Europe. If 2009 Europe 23% below is any guide, the Shiller PE for the US and Europe could reach 13X and 10X respectively, leaving Europe 23% below today’s levels. today’s levels One reason why most market commentators were totally caught off-guard by Covid19 is due to the relatively mild market impacts of previous pandemics with terrible death tolls: Spanish flu of 1918-19, (50 million deaths), Asian Flu of 1956-8 (2 million deaths), 1968 Flu Pandemic (1 million deaths). SARs, surprisingly, had one of the biggest market impacts even though it only resulted in 774 recorded deaths. That is because the European market was already very overvalued when SARS came along. The pandemic simply nudged it down below its 35-year average valuation. During the 1918-19 pandemic, the Shiller PE remained stable at around 6X even when the virus mutated into its second and deadliest wave. Levels of 13X on 18 March clearly seem low in light of medical advances and work from home policies. In 1919, the mayor of New York mandated different opening hours for business so that the subways would not be congested: a reasonable policy at the time but not as effective as not going to work at all. Figure 2. Stock market declines vs. Shiller PE valuations 130 120 PE 19.4x PE 22.7x 110 PE 6.6x 100 PE 6.1 while new & 90 deadliest wave hits 80 70 PE 16.8x PE 13x 60 Day-1 8 15 22 29 36 43 50 57 64 71 78 85 92 99 106 113 120 127 134 141 148 155 162 169 176 183 190 197 204 211 218 225 232 239 246 253 260 267 274 281 288 295 302 309 316 323 330 337 344 Europe (COVID-19) Europe (Sars - 2002-03) US (Spanish Flu - 1918-19) Sources: Factset for returns and Shiller for Cyclically Adjusted PE ratios www.econ.yale.edu-shiller/data.htm - Data as of 18 March 2020; www.mphonline.org/worst-pandemics-in-history The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC Global Asset Management. Consequently, HSBC Global Asset Management will not be held responsible for any investment or disinvestment decision taken on the basis of the commentary and/or analysis in this document. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target. Allocation is as at the date indicated, may not represent current or future allocation and is subject to change without prior notice. Non contractual document. For 3 Professional Clients and Institutional Investors Use Only.
Data watch as of 19 March 2020 Improved or better-than-expected Worsened or below-expectations Unchanged or in line with expectations F: Final A: Advanced P: Preliminary estimate Data Last Previous Economic Indicator Consensus Analysis as of data data The eurozone Composite PMI picked up to its highest level since August 2019, driven by services and manufacturing output. Although remaining weak, the rate of expansion improved for a third straight month despite PMI composite Feb P 51,6 51,0 51,3 signs of demand and production being dampened by the coronavirus outbreak and disruptions in supply chains. Service sector activity continued to rise despite some reports of lower tourist numbers Eurozone GDP growth softened to 0.1% qoq in 4Q, at its weakest pace since 1Q 2013, after an upward revision to 3Q (0.3% qoq from 0.2% initially). For 2019, GDP growth was 1.2%, down from 1.9% in 2018. Cross country, GDP growth QoQ 4Q F 0,1% 0,1% 0,3% unexpected contractions in France (-0.1% qoq) and Italy (-0.3% qoq), and a flat GDP in Germany were key drags on eurozone activity. Meanwhile, Netherlands, Spain and Portugal overperformed, with GDP growth at, respectively, 0.4% qoq, 0.5% qoq and 0.6% qoq in 4Q Eurozone industrial production contracted less than expected in January, ahead of the virus outbreak. Industrial production % YoY Jan -1,9% -2,9% -3,6% Confinement measures starting in March will however cause significant disruptions in the coming months The unemployment rate held steady at 7.4% in January as expected, for the fourth consecutive month, and at its Unemployment rate Jan 7,4% 7,4% 7,4% lowest level since May 2008. The labour market had remained strong before the global spread of coronavirus The trade surplus has steadily increased since Trade balance (goods, ex September, due to slowing imports, reflecting a softening EMU) Dec P 225,2 222,3 217,9 domestic demand. On a 12-month cumulative period, EUR billion (12Mth Eurozone imports have only risen by 1.5% yoy on cumulative) average, while exports have increased by 2.7% yoy Eurozone retail sales continued to slow (at 1.9% yoy on average over a rolling 3-month period), against a pace of 2.2% yoy on average in 2019. Eurozone retail sales are Retail sales % YoY Jan 1,7% 1,1% 1,7% expected to contract over the next few months, as drastic confinement measures have been implemented across the region Inflation Lower energy prices during the month accounted for much of the decline in headline inflation. Global demand - Headline CPI, % YoY Feb P 1,2% 1,2% 1,4% for oil has fallen following the coronavirus outbreak in China, weighing on energy prices. Eurozone core inflation - CPI core*, % YoY 1,2% 1,1% edged slightly higher to 1.2% yoy, remaining in its 0.6%- 1,2% 1.5% range observed since 2013 ECB Refinancing rate The ECB announced a comprehensive monetary policy easing package. This includes : (i) a new, temporary 0,0% 0,0% 0,0% programme to provide cheap loans to banks until June 2020; (ii) more favourable terms to be applied to the existing targeted longer-term refinancing operations by 12 March offering loans to banks below the ECB’s deposit rate of - Deposit rate 0.50%; and (iii) a boost to its asset purchase programme -0,50% -0,50% -0,50% by EUR120 billion until the end of the year (EUR33 billion/month), with a strong contribution from private- sector assets, in addition to its existing commitment to buy EUR20 billion a month In response to the Covid-19 crisis, the ECB added another €750bn in its Asset Purchase Pandemic Emergency Program, its highest ever pace of purchases. The ECB also decided to expand the range of 18 March Purchase Programme assets eligible for purchase to non-financial commercial paper and to ease its collateral standards to allow banks to raise money against more of their assets, including corporate finance claims. * Eurozone Core CPI is CPI excluding energy, food, alcohol & tobacco Sources: Bloomberg, HSBC Global Asset Management, as of 19 March 2020. The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC Global Asset Management. Consequently, HSBC Global Asset Management will not be held responsible for any investment or disinvestment decision taken on the basis of the commentary and/or analysis in this document. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target. Non contractual document. For 4 Professional Clients and Institutional Investors Use Only.
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