- Extreme risk-off: financial markets experienced severe distress and volatility after the international spread of the coronavirus and concerns over its effect on global growth. The rout was exacerbated by a sharp drop in crude oil prices as Russia and OPEC failed to agree to cut output to stabilise prices.
- Medium-term outlook: we remain cautiously optimistic on the 6-12 month prospects of risky assets and the global economy. But there are increased risks of a more damaging recession.
- Tracking the virus: the virus keeps spreading, notably in Italy and other eurozone countries. The US is the next large economy to be tested. But the experience of China/South Korea suggests that shutdowns can contain outbreaks.
- Macroeconomic situation: new data will be grim in major economies, but policy responses (along with health measures to control the virus) should help deliver our base case of a U-shaped economic recovery.
- Policy responses: it is encouraging to see fiscal policy being deployed as monetary ammunition is limited in some major economies.
- Our market dynamics indicators: our temperature metrics are flashing ‘dark green’, typically a good contrarian buy signal for risk. Our dynamic technical analysis suggests that we are still in a bullish cycle over the medium term.
- Asset allocation*: we remain moderately overweight risk, notably via emerging market and US equities, and underweight eurozone interest rate risk, where we increased our position recently.
- Looking ahead: we carefully monitoring the situation to possibly add to our risk exposure.
As the coronavirus spread, recent financial market moves have rivalled the daily swings during the Great Financial Crisis in 2007/2008 (see Exhibit 1). Risky assets were at the heart of this bearish and volatile action, with major equity markets now around 20% off the highs reached just two weeks ago.
Demand for safe havens has been equally extreme, with bond markets rallying sharply and pushing core market yields to all-time lows. In the face of a price war between oil producers, oil prices were in a free-fall this week.
Exhibit 1: Extreme risk-off since the mid-February equity highs: risk assets sold off, bond markets rallied sharply – graph shows the performance of selected asset classes as 10 March 2020
Source: Bloomberg and BNPP AM, as of 10/03/2020
Key views and asset allocation
Given the recent developments and our assessment, we prefer to stay overweight equities, as per our central case, but not to add to risky assets now (we have added equity calls spread strategies for flexible portfolios).
We prefer to keep ammunition to buy into the sell-off when there is more clarity on the outlook. In our view, for medium to long-term investors, the risk-reward trade-off in equities is much better after this correction.
We foresee an economic recovery as the virus wanes and policy support kicks in, but the downside risks of a more prolonged global slowdown or recession have clearly increased. We are cautiously looking for opportunities to add to our risk exposure.
In government bond markets, given the moves to all-time lows for yields, we have increased our underweight position in eurozone interest rate risk in recent days.
We view Italy as one of the weakest links given its economic vulnerabilities and little scope for fiscal and monetary (ECB) support. We have Italian government bonds on our radar for potential additional underweights.
Also read G3 interest rates: Going, going, gone?
*Views expressed are those of the Investment Committee of MAQS, as of 10 March 2020. Individual portfolio management teams outside of MAQS may hold different views and may make different investment decisions for different clients.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.