Fear should not drive investment strategy

Fear should not drive investment strategy

The coronavirus outbreak and related shocks to the economy have unsettled financial markets in recent weeks, a situation now worsened by the inability of OPEC and its allies to agree on further production cuts. Oil prices collapsed on 9 March, falling by 25%, and the S&P 500 closed down 7.6% in a historically bad day for markets.

Though the backdrop appears decidedly bleak, investors should be wary of taking sides and should not try to time the markets.

Over the past few weeks, the spread of the novel coronavirus on an international scale has caused sharp corrections in equity markets. Implied volatility, a measure of uncertainty, as well as long-dated bond yields have reached levels only seen in periods of prolonged market turmoil. While the sharp rise in volatility suggests that markets are moving toward panic mode, we believe it is still too early to see current market dislocations as a trading opportunity.

Shock after shock: Putting the economic impact into perspective

Measures to contain the coronavirus have disrupted manufacturing supply chains and induced a supply shock across broad parts of Asia. The latest country to be severely hit is Italy, which has introduced dramatic containment measures nationwide. These supply shocks are now being followed by demand shocks as consumption of goods and services is reduced. To make matters worse, global growth is being hit by a third shock: the disagreement between Saudi Arabia and Russia on production cuts sent oil prices on a downward spiral, falling by 25% in a single day – the largest drop since 1990. While the lower oil price will eventually be good for consumers, it is negative for European and American oil producers, and can negatively impact credit markets as well.

Financial markets are currently pricing a sharp fall in economic leading indicators, such as purchasing managers’ indices and industrial production, and economic activity, but there is no evidence of a permanent deterioration. Collapsing bond yields maintain a high and attractive equity risk premium, but it is too early to call a trough in equity markets. In fact, very high volatility in equities will persist in the coming weeks as the viral outbreak accelerates outside of China and policy makers race to find a concerted response to get ahead of the curve in markets. So far, the monetary and fiscal policy responses to this crisis are neither convincing nor clear enough, and markets will be watching very carefully for signs on this front when finding and building a base.

View on Equities

Acknowledging the uncertainties related to the spread of the virus, however, we do expect that Europe and the USA will eventually be able to contain the outbreak in a way that avoids pushing the global economy into an outright recession. This should allow equities to regain lost ground as confidence is slowly restored over the next 3 to 6 months. Attention should then shift back to fundamentals such as equities’ attractive dividend yield, especially compared to sharply fallen bond yields. Nearer term, weaker economic indicators and rising numbers of infections are likely to continue to weigh on sentiment, competing with likely upcoming monetary and fiscal policy measures to determine market direction. As mentioned, we think that politicians still have to catch up with the challenges ahead. We thus prefer a neutral equity allocation in portfolios at this juncture.

Bondmarkets

As soon as we see signs that the mix of containment measures and economic policy responses is successful, we also expect that the sharp drop in global bond yields will reverse course. Current levels reflect the sudden search for safehaven assets and appear sustainable over the longer run only should a deflationary outcome emerge, which we do not believe to be the case.

Commodities

Oil markets as well as base metals suffered the most when a severe production shortfall in China became apparent. When it transpired over the weekend that Russia was leaving OPEC+ and Saudi Arabia was threating a price war, oil markets took another hit. We think that it is too late to sell into the market. We thus maintain an overweight position in the overall commodity index, which also includes precious metals. These help to diversify virus-related risk.

Temper panic with patience

More negative economic data in the weeks ahead is to be expected, as the negative effects of the shocks materialize. We will be watching for signs that the virus spread is slowing; that policy measures to mitigate the impact of the virus are effective; and that high-frequency economic data, such as travel patterns or consumer spending, start to normalize. With financial markets moving so fast and affected so significantly by daily news flow, investors should be wary of taking sides and should not try to time the markets. It is in times like these that diversification across asset classes provides the best hedge.

Liv Brøndum

Boligforeningsrådgiver - Finansiering, projekter og drift i boligforeninger

4y

Laurids Egedal Kirchhoff Læs den her min bror har skrevet :-)

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Anselmo Donato Silva

Administração / Finanças / Contabilidade / Controladoria / Membro ANPPD® / Anbima CPA 10

4y

The pragmatism of his point of view reflects the wisdom of the challenging and dynamic market of the information age.

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José Brandão

Financial Advisor, CEFA® for Major Clients: High Net Worth Individuals and Family Offices

4y

Well done. Simple to read, but very accurate and pragmatic.

Norman Roesch

Founder & Managing Partner bei Coreleus GmbH Real Estate. Projects. Advisory

4y

Well spoken, Michael!!

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