The corornavirus is dominating the news flow and making financial markets shiver. It first appeared in China but is now spreading through Asia, Europe, the Middle East and the US. What are we looking at? What can we expect? And above all, how does it impact our asset allocation?
What are we looking at?
The 3 D’s
Depth, Duration and Diffusion will be key in assessing the economic pain of the coronavirus.
The depth refers to the intensity of the coronavirus’ impact. The virus continues to severely disrupt activity in China. Transportation is hindered. Hence, there is a lack of workers to produce, a lack of goods to manufacture and a lack of consumers to purchase. Sales survey have recently hit new low’s. Car sales have plunged 92% during the first 2 weeks of February as a majority of show rooms are closed.
Duration refers to the length of the epidemic. So far, market assumptions were that by March, a blend of companies would be back to work, others at a sub-normal pace or middle-ground pace. These assumptions might have been too optimistic. The data was focusing on China. It had not taken into consideration the rapid spread to other neighboring continents.
Diffusion refers to the geographical impact of the virus as it knows no border. In spite of the early containment measures taken by China, where the virus broke out, today’s ultra-frequent international traveling means that by now the virus has easily spread to anodine places: a cruise boat off of the Japanese coast, a hotel on Tenerife, a handful of Northern Italian communes, just to name a few. As far as Europe is concerned, we keep a close eye on Italy. Italian PMI’s were bottoming this winter, confirming that its economic cycle was gearing towards recovery. In addition, the North of Italy is the heart of the economic activity and industrial production. The region plays a major economic role. Hence, financial markets reacted sharply.
What can we expect?
Short term
In the short term, we can expect increasing volatility in the markets. We also expect an impact on economic soft data. The trend was showing a bottoming out of leading indicators at the end of 2019 and early 2020. We expect a temporary halt to that trend and/or a deterioration that will be visible in the next published data. China will publish its next PMI on 29 February.
Medium term
In the medium term, there is rising expectations of policy easing from central banks and fiscal support. Markets are now pricing at least one cut in the Fed funds rate during the first half of 2020. So far, international central banks have said little except that they recognize the coronavirus as a threat and are monitoring.
What have we done in our asset allocation positioning?
The term coronavirus appeared in the local Chinese news on 31/12/2019. China’s New Year was on 25 January 2020. We were overweight equities until the 24th of January.
We have been neutral equities ever since and had derivative strategies in place to mitigate the effect of a market drop. They played their role. We are now underweight equities. We have focused our analysis and the risk reduction on equities since it was the asset class that had shown the highest level of complacency.
We keep a preference for gold as a hedge.
In the following weeks, we will remain opportunistic and carefully attentive to the evolution of the news flow and investor sentiment, to tactically monitor and inform you on our exposure to Equities.