Macro insights

COVID-19 : Understanding the impact on investments

Given the impact the coronavirus has had on markets so far, the short-term outlook remains very uncertain, particularly around when the virus infection rate will peak.

What is clear is that the virus is having an overwhelming impact on some areas of economic activity, which we expect will be confirmed in data and corporate earnings statements in the weeks to come.

Our macroeconomists have lowered their 2020 global growth expectations from 3.2% to 2.6% - and this includes downward revisions for all regions of the globe.

However, we have already seen policy responses from the US Federal Reserve, while Australia’s and Canada’s central banks have also cut interest rates, and we expect further monetary easing in due course.

The European Central Bank’s response is more likely to be around the availability of liquidity, given where interest rates are. We also expect governments to announce further spending packages in an effort to contain the impact of the disease. As a result, government budget deficits will increase.

What can we expect from here?

While the outbreak might well be temporary, we expect long-term repercussions on consumer behaviour and business activity, as well as economic and health policy. There are also likely to be long-lasting implications on household wealth and pension funding ratios – and potentially credit availability as well as earnings across different sectors, including the financial sector.
The return of a ‘business-as-usual’ environment will likely take a long time, and this will impact how investors look at their investment strategies.

The market has already priced in a significant hit to global economic activity and shifted capital towards perceived ‘safe-haven’ assets - bond yields reached record lows at the start of March, in a number of markets. But the wide diversion between the recent performance of equities and core government bonds has demonstrated that asset class diversification remains a very valid investment theme.

We expect that volatility is likely to remain high, at least in the short-term - and we are focused on managing and limiting the risk to our strategies.

Equities shaken

Despite the recent volatility and steep fall in share prices, equity markets have remained relatively orderly, given the current challenges. In the week to 5 March, the MSCI World NR Index is up almost 1% - a stark contrast to the previous seven days. 
The impact on corporate earnings is difficult to predict. The market had been expecting global earnings growth of approximately 8% to 10% this year, but now zero is a possibility.

Concerns over the supply side challenges emerged first, most notably after China shut down a significant amount of factory production. We may see companies start to review their supply chains and spread supply across different countries if they are overly reliant on one particular geographical region.

But our philosophy is to remain invested in quality growth stocks, which have been relatively well protected from this downturn. We are starting to see some weak balance sheets being threatened and that is why we are staying in strong cash-generative businesses.


Fixed income rotation

Fixed income markets have also seen a high level of volatility recently with yields on 10-year US Treasuries reaching a record low and credit markets widening significantly. However, in terms of market volumes, we have not witnessed any significant flows or evidence of reallocation from investors in active funds.

Over the past few weeks we have been reducing active risk in our fixed income strategies. In credit, we have sold high-beta positions and cyclical names. We remain very cautious in the short term, but in the medium term, we believe credit will remain supported by the search for yield.

In our Asia fixed income strategies we have reduced some of our Chinese high-yield risk and moved out of B-rated names into BBs. We have initiated some hedges and added duration through primary markets in Europe and rotated out of some high-beta credit and replaced that with low volatility investment-grade names.

Multi-asset tactics

As the coronavirus spread to Europe, we reduced our overweight position in equities and adopted some mitigation strategies, for example investing in defensive currencies – though not the US dollar, as we expected the Federal Reserve to reduce rates and the dollar to weaken.

But we remain positive on equities over the medium-term and during the market sell-off, have been selectively buying some stocks with very strong business models. Following previous epidemics such as SARS and H5N1 (bird flu), we have witnessed the market deliver a v-shaped recovery, but we expect the recovery post-COVID-19 is more likely to be u-shaped.

The virus outbreak appears to have been contained in China. Markets are now looking out for the first sign that the number of cases outside of China is under control. When this occurs, it will likely trigger more exposure to equities within our strategies.

Next policy steps

Uncertainty will likely be the dominant sentiment in the short term. But we can take some reassurance by policymakers stepping up - as evidenced by the central bank actions so far, and G7 finance ministers’ pledge to use “all appropriate policy tools” to support economic growth.

*Source: Factset, data as at 05/03/2020 in US dollar terms.

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