Our stance on the coronavirus given renewed market concern
In light of the recent market developments with two new epidemic centers in Italy and South Korea, the GIC (Global Investment Committee) of Societe Generale Private Banking convened this morning to review our current asset allocation. As risks of a full-blown global pandemic have risen we carefully reviewed our allocation.
Risk assets are likely to stay volatile until the spread of the disease appears to be under control. Compared to previous epidemic outbreaks, this instance will certainly yield a stronger economic effect due to severe disruption in global supply chains. Impact on markets is already very similar to previous outcomes and sentiment indicators have hit panic levels. We do believe the probability of a protracted market sell off is low and pent up demand will imply a sharp rebound in economic activity as early as in the second quarter of 2020.
While not immune to the market sell off our diversified portfolios proved rather resilient due to well-functioning firewalls with Gold, the dollar and long dated bonds performing well. Within equities, our focus on quality and visibility continues to add value.
We believe current market movements open opportunities and while it might be premature to add risk we decided to stick to our current equity allocation with a neutral stance on global equities. We however highlight emerging markets as being more attractive, not only due to low valuation but also as we believe the peak of the epidemic outbreak in China has been reached. Among commodities, we move Oil to overweight after a sharp underperformance.
A sense of market panic
The spread of the Coronavirus in Asia (South Korea, Iran) and Europe (Italy) is raising alarm bells and giving investors reasons to take profits on risk assets after an impressive rally (The MSCI World index was up +12% over the past six months as of 24/02/2020).
The lockdown of several thousand people (52,000) in the north of Italy raises additional question marks about the global economic impact after several million people were locked down in China. The situation has started to normalize in China. Most industrial firms have resumed production but capacity utilization stays low. In Europe, Germany’s business association expects supply shortages related to the Coronavirus.
Macro data releases in the coming weeks will be highly distorted. China has delayed most data releases in February. In the coming days, PMIs (Purchasing Managers’ Index) due for February will give some indications about the economic disruptions.
Our market views
Taking a longer perspective, we note that it is not uncommon for markets to have second thoughts after a viral outbreak (with all the disclaimers associated to the difficulty to isolate the effects of epidemics on markets). In the case of the Swine flu in 2009 and SARS in 2003, the market recovery (after the initial hit related the outbreak) was interrupted by renewed uncertainties before rebounding.
The growth rate of confirmed cases has continued to decline globally despite the concerning news about the international propagation of the virus. It stood below 3% in the last seven days. The number of recovered cases has reached 28,000 people (1/3 of confirmed cases have thus recovered). Quoting Columbia University’s director of the Center for Infection and Immunity (08/02/2020) “If measures taken so far to contain the outbreak are effective, some dramatic reductions in infections should be observed in the third or fourth weeks of February. Warmer, early-spring weather might also impede transmission”.
Three market scenarios:
- Worst case: Coronavirus outbreak goes out of control in other Chinese regions than Hubei and in Europe. Lockdown extends to several million people in Europe. The MSCI World is down -10% from current levels (equivalent to the drawdown between Aug. 2015 and Feb. 2016 when global recession fears jumped). 10Y Bund yield falls to -0.8% (record low). VIX spot spikes to 35-40 (Dec. 2018). High Yield credit spreads jump by 300bps in EUR and 500bps in USD to 650bps and 850bps, respectively (back to early 2016 highs). Probability 15%.
- Base case: Market volatility continues over the next days and risk assets bottom in the first half of March as the epidemic peaks. The MSCI World index troughs at current level (back to end-Nov 2019 level). 10Y Bund yield bottoms @ -0.6% (end-Sep 2019 level); 10Y Treasuries bottom at 1.3% (all time low). VIX spot stays below 30. Probability 75%.
- Best case: if the Coronavirus peaks in the coming few days and/or a change in methodology revises down the number of confirmed cases and/or the number of recovered cases jumps significantly, the market will experience a sharp rebound. Concurrently, the economic impact could remain contained but in the face of uncertainty, fiscal and monetary authorities signal more accommodation. Risk assets rebound from current levels. Bond yields stay nonetheless below pre-17/01 levels until early Q2 (10Y Bund yield stays in the -0.2 to -0.3% range; 10Y Treasuries in the 1.7-1.8% range) and contribute to fuel equities. Probability 10%.
Written on 26.02.2020 by David Seban-Jeantet
Chief Investment Officer - Société Générale Private Wealth Management