We project an 80-90% normalization of commercial activities by year end, and a full normalization by 2021, as indicated by current data, even as the equity market remains difficult to time. Since the path to full normalization remains bumpy, and markets have not priced in the recovery scenario we envision, we expect volatility to remain elevated.

The Covid-19 public health and economic crisis progressed fast. In January, the market concern was “will Covid-19 spread in China?” In March, it was “which countries, sectors and companies are the most vulnerable to a prolonged lockdown?” Finally, in June, we asked “what will a recovery look like and how much has been priced in?” These questions are becoming more difficult to answer – in a crisis with almost no historical precedent, it is easier to predict an eventual end to the lockdowns than to pin down the shape of a recovery. This is especially true given evolving policy responses of a historical scale and likely virus resurgence in certain areas after they reopen. As markets recovered from the bottom, we asked ourselves “what now?”

Mimicking the mechanical rebound of economic activity from the nadir when global mobility started to recover from a standstill, markets reversed a significant part of their losses in Q1, bouncing off the March lows by a range between 18.6% (for the MSCI FM) and 38.5% (for the MSCI World) with smaller markets predictably lagging larger ones. Performance continues to reflect a high level of equity price correlation and the heavy influence of factor exposures rather than stock level idiosyncrasies.

The anatomy of the economic and market recovery so far has a couple of noteworthy characteristics:

  1. Even though the epicenter of the current health crisis has shifted more towards the emerging markets bloc, there are no uniform policy reactions or mobility limitations. In fact, smaller emerging and frontier countries are increasingly softening restrictive policies despite increasing case numbers, as many cannot afford to do the alternative. A recent UBS survey in Indonesia reported that “East Java retail traffic recovery (is) robust despite rising COVID-19 cases” and that “Indonesia consumers are increasingly facing COVID-19 fatigue...(and) 54% of the respondents (to the survey) stated that the probability of getting infected...was very low.”i Similarly, Egypt is reopening its border with the hope of revamping its tourism industry despite a still elevated number of cases. It is increasingly likely that countries, especially those with fewer resources, are prioritizing economic activity and adapting to the new normal. And they may not face the same moral dilemma as developed countries: A recent paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on June 25 cited much lower mortality rates in most developing economies compared with advanced economies. The authors cited younger populations (e.g. 17.5% of Italians, vs 2.2% Ethiopians are older than 70) and lower obesity rates (35.2% adults in the United States vs. 2.1% in Vietnam) as possible reasons. We therefore believe that to calibrate economic and earnings impact by using just Covid-19 case numbers as a factor would be ignoring such nuances.
  2. There is currently no obvious correlation between equity market performance and the pace of mobility recoveries, except for China (see figure 2). There are a couple of plausible explanations including: 1) Markets continue to exhibit high correlation with no regard to fundamental differentials; 2) pre-existing economic fundamentals of the markets outweigh the severity of the pandemic’s impact. We believe both played a part, although high asset price correlation, a signature phenomenon during early stages of most crises - dominated, in our view, given how the pandemic has become an overarching economic concern in recent months. This also means that current market inefficiencies will likely create medium term opportunities. Figure 2: Mobility level compared to baseline vs. Equity market performance YTD in USD

Source: Google mobility report as of July 3rd, 2020. Bloomberg. Note: Data excludes China due to lack of availability

  1. A historical divergence between growth and value is reaching extreme levels in both emerging and developed markets. In fact, the MSCI EM Value Index returned just ~12.6% this quarter, versus 22% for the MSCI EM Growth index, which was predominantly driven by the IT and e-commerce sectors. The valuation difference between growth and value in emerging markets has also risen to the height of the early 2000s (figure 3). There is no doubt that the pandemic acted as an accelerator for further digitalization and e-commerce adoption. However, as these themes approach “no- price-too-high” proportions, markets seem to overly discount the recovery potential of the “brick and mortar” economies. Such extreme performance and valuation divergence explained some of the outperformance of larger emerging markets, especially those in Asia, against smaller emerging and frontier markets: The MSCI Emerging Market Index, in which China’s weight is 40.95%, also has over 30% weight in IT and e-commerce. This compares to a sub-1% IT and e-commerce weight in the MSCI Emerging Market Horizon Index, and a negligible weight in the MSCI Frontier Market Index. Similarly, such factor divergence also explained some of the outperformance of developed markets against emerging markets. The MSCI World Value Index was -19% YTD versus 6% for the MSCI World Growth Index. Figure 4 illustrates the large difference in the technology sector’s representation in various regional markets.

Figure 3: Performance and valuation divergence between emerging market value and growth

Source: Bloomberg

Figure 4: Representation of cyclical and technology sectors across regional markets

Source: JPM Morgan Research

We agree with the trend implied by the market, but not quite the magnitude. The bottom line is that, excluding the technology and e-commerce sectors, which have been almost the “only play in town” year- to-date, not much recovery in the “offline economy” is being priced in, especially in small emerging and frontier markets where a vast majority of the economy remains offline.


Our assumptions that the virus outbreak cycle (outbreak escalation → social mobility restriction → new cases peak→ social mobility relaxation) would last for months (not years), with at least two months of total revenue loss in offline business operators, seem to be more or less correct. In the case of the timing of mobility relaxation, however, we observe a tendency for mobility relaxation to decouple with infection curve, as some countries enter a phase of “pandemic fatigue,” and others simply can’t afford keeping their economies on “pause”. As such, we have passed the worst in terms of economic “inactivity” earlier than expected.

To model the shape of the recovery is admittedly challenging due to the lack of historical precedence. The influence from epic scale policy stimulus, a potential second wave of infections, as well as social behavioral trends make any prediction prone to error. We therefore expect the market’s recovery path to be bumpy, as expectations need to be constantly tweaked. That being said, datapoints from some of the early exits continue to provide evidence based on which we build our own expectations. We illustrated a few below:

  1. It took a short amount of time (2-3 months) for consumption to return to 80-90% of the normal levels, but 100% normalization takes time. Recent data confirmed that Chinese private consumption very quickly rebounded to just a 3% YoY contraction in May 2020. Beyond such quick rebound, a recent UBS consumer survey indicated that “only 11% (respondents) anticipated higher income y/y)” indicating low probability that consumption will show positive YoY trend within this year. Data from Vietnam seems to corroborate the ability for consumers to bounce back rather quickly to a 70-80% level within a month. According to our sources in the field, regarding shopping mall footfall, shortly after the social distancing campaign was over, “total footfall was ~50% compared to the same period last year. Traffic in the first half of May was 60% compared to normal levels, with weekend traffic improved to 80-90% compared to the same period last year. In the second half of May, total footfall was 70% compared to the same period last year, with foot traffic on weekends equivalent to 90-100% of last year. For some retail malls in Hanoi and Ho Chi Minh City, footfall experienced YoY growth of ~10-60%...”
  2. Despite the relaxation of mobility restrictions, countries with less control over infection rates and/or experiencing second waves will likely see a slower pace of recovery towards 100% of their pre- infection consumption levels. This is due to a mix of lingering capacity and opening hour controls and consumer sentiment. Nevertheless, the first quick rebound towards 80-90% of the normal level still seems to be happening, especially for mid- and high-income consumers. Indonesia is a recent case. Despite continued high infection cases nationwide, especially in East Java, we see a quick foot traffic recovery to only 15% below pre CoVID-19 baseline within the first month of re-opening, with dine-in F&B and popular fast-fashion brands leading the recovery. Nonetheless, there seem to be signs of week to week traffic flattening after the first month.
  3. Some behavioral changes may linger, if not become permanent. According to the same UBS survey of Chinese consumers, the existing trends of digitalization and increased online spending continued after the pandemic, and so did increasing spending on healthcare and self-improvement, such as sports, cosmetics, and education. Meanwhile, despite the initial recovery, there seems to be a semi- permanent reduction on the expectations to travel and dine out.
  4. Despite the faster adoption of digitalization around the world, there is no evidence supporting the conventional wisdom of a broad apocalypse of the offline economy. This supports our previous statement that “we agree with the trend implied by the market, but not quite with its magnitude.” This is particularly true in economies where a vast portion of the offline economy is still informal and penetration levels still have considerable space to improve. Even in China, where online commerce has had the highest penetration and most rapid growth over the last decade, one would be surprised to learn that shopping malls have done quite well over the same period, with retail sales outperforming the country’s overall trendiv due to a still low penetration. Our investment universe’s formal retail penetrations further lag that of China. As lockdowns are being wound down, consumers continue to shop online, but they do also quickly go back to physical locations in most cases.

In conclusion, we project an 80-90% normalization of commercial activities by year end, and full normalization by 2021, as indicated by current data. Equity market timing, however, is not as straight forward. As we wrote in our last report, “there is a history of asset prices bottom before associated defaults, bank failures and delinquencies started to improve, and the market has the tendency to ‘look across the valley’ when there’s a glimpse of the light at the end of the tunnel.” We continue to hold this view. However, as expectations may run behind or ahead of realities in the complicated path to full normalization, we expect volatility. One thing is clear, outside of the IT and e-commerce segments, markets have not nearly priced in the recovery scenario we envisioned above.

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