The Coronavirus epidemic has put a stop to the particularly favourable environment for risky assets since the end of 2018.
- In addition to the human impact, this crisis will have severe short-term economic consequences. The key to determining possible market scenarios, will be to evaluate the extent to which this crisis will be hampering economic activity.
- In this environment of uncertainty, it is necessary to act with caution and to give priority to liquid assets until the market fully considers the impacts of this epidemic.
Financial markets remained stable as long as the epidemic was contained within the Chinese territory but reacted negatively when global spread appeared inevitable. Beyond the health risk, the market reaction reflects expectations of lower global growth and severe downward adjustments in corporate profits.
The unprecedented nature of this crisis makes economic and financial projections complicated.
Beyond health developments, there are only a few concrete economic elements to rely on today:
- The first economic indicators incorporating the effects of the epidemic were published this weekend. The Chinese PMI thus stands at 35.7, well below expectations but more importantly, at levels unseen since 2008. It is in line with a very severe scenario of instant contraction of Chinese growth. Probably around -4%.
- Asian SME indexes published on March 2 do not show any collapse. However, this is due to the very recent development of the epidemic, and more substantial slowdown are to be anticipated throughout the second quarter.
- In Europe and in the United States, indicators do not yet reflect the consequences of the epidemic. It will be important to monitor the production components, as well as inventory levels and procurement lead times
The medium-term political consequences may be significant as each government will be accountable for its management of the crisis. Inadequate crisis management will have to be defended. We consider some of the political aspects to be particularly impactful for financial markets:
- Monetary action, possibly concerted action by central banks, including the FED and ECB. This will be possible only when health information begins to translate into tangible economic data. Central banks will then be able to react to any disruption in financial markets through announcements targeting liquidity, new TLTRO, large-scale asset purchases and even rate cuts. However, they will not be able to avoid the forthcoming economic downturn.
- A significant budgetary response. This may take longer to implement on a large scale, particularly in Europe because of governance issues.
- Finally, markets could re-evaluate the likelihood of Donald Trump's non-re-election, which has so far been very low. Some elements of Democratic programs may then require applying an additional risk premium to U.S. equity markets.
Perspectives. China is currently most likely in recession and there are strong credible scenarios of global slowdown along with significant uncertainties concerning the length of this slowdown. The "U"-shaped growth scenario, with uncertainty concerning the dynamics of the recovery, is already projected by some industrialists such as BASF for whom the slowdown will occur throughout the second quarter of 2020.
We consider that equity markets, and to a lesser extent bond markets, have for the time being only partially priced the economic and human damages of the situation and that visibility regarding the evolution of market conditions will remain low.
Meanwhile, we should probably anticipate negative information to be released, whether it is about the spread of the virus or the economic trend, which would prevent markets from rebounding durably to pre-crisis levels. It is therefore necessary to remain cautious on risky assets.
Assets and liquid hedges should also be preferred. Indeed, the rebounds in bear markets are often very violent and political announcements may require rapid adjustments to the exposures.
Jean-Luc HIVERT Chief Investment Officer, Achieved 2020 | 03 | 02