Risk assets continue to fall amid virus and economic uncertainty

What is the latest on the virus?

Developments around the Coronavirus evolve at a high pace: yesterday the World Health Organisation (WHO) called it a pandemic, the first time it has done so since the swine flu in 2009. Italy has extended the lock-down to the whole country, closing all restaurants and shops except for pharmacies and supermarkets until April and the US prohibits all Europeans (ex UK) to enter its country for 30 days from tonight. President Trump‘s announcement to apply travel restrictions to/from Europe, calling the Coronavirus a “foreign virus“, caused even more uncertainty not least about the real danger of the virus for the US. While it looks more and more under control in China, Japan and South Korea, the virus is still spreading further globally.

We keep a close eye on the pace of growth of the virus and appreciate that the current data we are looking at is not reflecting the measures which most countries started enacting a few days ago. We are therefore watching for any signs that the new and likely further containment/lockdown measures start having an effect on the spread of the virus. While complacency rates were higher than we originally thought in Europe and in the US, authorities seem to be grasping the issue and are now addressing it. The next few weeks and months will therefore be crucial in determining whether the spread gets contained, and how deep the resulting economic damage may be.

What about the market reaction?

Most equity markets are down around 30% from their peaks. At a regional equity level, emerging markets have fared relatively better while Europe ex UK is lagging. At a sector level, consumer staples and healthcare are outperforming while energy and financials are the worst performers. In fixed income, credit spreads are widening to levels last seen in the 2015 energy/China-related slowdown, while government bond yields have fallen to all-time lows as markets anticipate further rate cuts globally. Interest rates futures are now pricing that the Federal Reserve will cut interest rates to almost 0% in the coming months. This shows the extent of the policy response the market believes is necessary.

How deep a possible recession will be remains uncertain and this is what the market is trying to evaluate at the moment. We are seeing a broad-based derating as a result. The real economic damage will also depend on further developments, such as the level of effectiveness of emergency measures announced by policymakers. While the UK made significant announcement on the monetary and fiscal side yesterday, following a number of Asian countries, we have so far had little indication of pre-emptive measures from the European Union and the United States.

What is our view?

At Brown Shipley, this is not the time to panic or throw in the towel. We advocate moderate risk levels in portfolios overall with a small overweight to equities maintained. Portfolios should be constructed in a diversified way, including assets such as government bonds (especially US Treasuries) and foreign currencies. While traditional negative correlation to risk assets such as equities can prove to be volatile over a short period of time, we remain convinced that correlations will continue to hold and therefore diversifiers still have a role to play.

With investor sentiment reaching low levels, the ongoing correction will also provide opportunities. We will keep a close eye on this to take our chances once we believe the probabilities are most in our favour. This will involve balancing our view on asset valuations with the various scenarios for future economic and profit growth. We will keep you updated on our view accordingly.

If you have any questions please contact your usual Brown Shipley adviser.

The Investment Office

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