We expect uncertainty surrounding the duration and magnitude of the coronavirus to continue to generate volatility in global equity markets until the spread of the virus slows.
With the hit to earnings well underway, proper modeling remains ephemeral. We suggest sitting tight until some evidence of earnings stability is established. We urge investors to remain cautious before looking to take advantage of lower prices as we believe further negative news is likely and do not expect an imminent and decisive recovery in prices.
International and EM equity markets are increasingly fragile due to shocks from the virus and oil prices, and selective exposure is suggested. Although we continue to view them as attractive long-term investments, price fragility remains high until some degree of positive news is received.
Emergency actions by the Federal Reserve should help stabilize liquidity in the Treasury market and allow yields to find firmer footing. Expect a steepening of the yield curve as a result of policy movement and for the correlation between stocks/bonds to return to a low or negative level.
Even in the case of a V-shaped recovery beginning in the 2H, volatility is likely to remain elevated and high-quality fixed income offers a much-needed buffer.
There is concern over the liquidity and resilience of high yield and leveraged loans and we view them as vulnerable asset classes in this environment. As such, we suggest reduced exposure to liquid instruments in these areas to minimize daily price swings that can induce further fear.
We expect the USD to appreciate as uncertainty regarding the depth and length of the shock, and the associated financial market volatility, drives flows into US safe assets.
The increase in demand for US Dollar cash from international investors, as seen by the widening in the USD cross currency basis, also provides support to the currency.
As US rates converge closer to rate levels in the rest of the world, the appreciation may be somewhat limited. However we do not believe the narrowing of interest rate differentials to be sufficient to drive broad USD weakness.
Risk mitigation via liquid alternative strategies such as absolute return, market neutral and other hedging approaches can provide investors with enhanced bear market protection in these extreme environments.
Investors holding private or locked-up alternative investments are shielded from daily market swings and panic selling by the sheer nature of illiquid investments.