News & Insights
MARKET CONTEXT: There is continued Impact from the Coronavirus which is now spreading through-out the rest of the world. “How deep will the economic impact be” and “how long will it last” are the two uncertainties currently impacting the financial markets.
1. Global Macro: The Coronavirus outbreak is a Black Swan and is having an exceptionally large impact on financial markets but it should not last. Global geo-political synchronization is taking place to reduce human casualties, recession and the meltdown of financial markets. On March 3rd, the Fed cut its discount rate by 50bp with no warning. Meetings with the G7, ECB and other Central Banks took place to coordinate a multi-dimensional response to the epidemic, including: accommodative financial conditions, potential fiscal and budget stimulus to prevent corporate bankruptcies. So far China has succeeded in containing the epidemic and its economic activity is progressively coming back to normal. The rest of the world should have a similar experience with the crisis forecasted to end within 2020. As a base scenario we can expect some recovery of the global economic activity at some point in 2020 and therefore avoid a meltdown of the global financial markets. As a consequence of the growing epidemic outside of China, risky assets such as equity and credit may experience more downside with heightened volatility before they start recovering in anticipation of a normalization of the global economic activity.
2. Financial Markets: Equity: Year to date the Hang Seng sold off -7.3%, S&P500 -8.3%, Eurostoxx -13.8%. Fixed Income: 10 year US treasury yields decreased 1.20% to 0.70% which is an all time low (US treasury rally) and pulled up the Emerging market government bonds in USD while EM local currency bonds sold off. Corporate bonds sold off with High Yield spreads widening: US & Europe +1%. Currencies: with lower US rates, USD sold off against DM currencies and rallied versus EM currencies in February: EUR +2.4%, AUD +2.1%, CNY +1%, RUB -2.6% and safe havens JPY +2.6% and CHF +3%. Commodities: Global Sell off of industrial commodities and a rally of precious metals: Oil -8.2%, Gold +5.5%.
3. Risks: The Coronavirus is a new geo-political risk, its amplitude and duration unknown, yet it is expected to fade out by the summer. The rising risks linked to the epidemic are corporate failures induced by both supply and demand shocks as well as disturbed credit markets.
Risk Management: The volatility has risen substantially. Consequently the Equity, Commodity and currency downside are systematically minimized. The portfolio continuously accumulates income from its bond allocation (average duration of 4.6 years) while upward exposure to safe havens such as US treasuries and Gold are increased.
4. Opportunities for 2020: Equity: As China’s economic activity is progressively normalizing, Chinese equities are best positioned to recover first with a cheap valuation compared to any other markets, even prior to the epidemic, with substantial earning per share growth for 2020 (above 0 with the possibility to be above 5%) and an attractive dividends policy. Fixed Income: US treasuries are rallying in this context which may persist. Any potential Fed rate change would be a cut. Commodities: Gold: the safe haven status, the new series of implied Fed rate cuts and the USD weakness, all underpin a continuation of the gold rally.