Last week global markets experienced their greatest weekly losses since the collapse of Lehman Brothers in 2008, triggered by a pickup in coronavirus cases outside of China.

US equities are down 10% and markets across the world are down between 6% and 12%. Last week there were more new cases of the virus reported in the rest of the world than in China, and investors are worrying that as nations around the world impose quarantine measures this will impact economic activity. Already analysts are revising down global growth estimates and slashing earnings numbers in the US and Europe.

Total number of cases Source: CSSE 2nd March 2020

Risk-free rates markets have moved aggressively to lower yields, behaving how we would expect them to in such an environment. The 10-year US treasury yield has moved from 1.92% at year-end to a record low of 1.06% as of mid-afternoon on Monday. The front end of the yield curve has also moved lower, with two-year US treasury yields down at just 0.75%, even with the Fed Funds rate currently at 1.50% to 1.75%, clearly implying that the fixed income market expects rate cuts imminently.

Change in fixed Income yields. Source: Bloomberg March 2020

What type of recovery do we think will occur?

Already analysts are revising down global growth estimates and slashing earnings numbers in the US and Europe. We agree with these downgrades in the short term and think that a quick V-shaped recovery is not likely. However, we do think a U-shaped recovery will occur during this year. This does not mean that volatility has gone away or that losses will be recouped very quickly. News flow will continue to dominate short term reactions in markets, but this should not last forever. We do also think that technical recessions may occur in some parts of the world, but these will be short lived and these regions will recover. Global growth will be lower but still positive. Earnings will be hit during the first two quarters but if the containment of the virus does continue to drop the total number of cases and a vaccine does become available, we believe companies should recover moving into the second half of the year.

Will global growth be delayed or derailed?

Identifying the impact of the virus on economic activity and prospects for future growth is difficult. Comparisons have been made to previous epidemics which can help identify some trends. However, we feel that wholly focusing on these is not best when predicting what might happen in the future.

Global economies have developed over time and infection & death rates of Covid-19 are different to the SARS, Swine Flu and Ebola epidemics of the past. The general public travel far more and the spread of this type of virus is far harder to contain. China is now the second largest economy globally and has a large global footprint regarding supply and demand of goods and services. With China being so affected by this, the ramifications of a China shutdown are huge. Currently China is moving back towards more normality with a slow increase in employees return to work and an increase in supply of goods. As of last week, data showed an increase to 50-60% business capacity up from 30-40% the week before. Markets will continue to focus on this data to make sure the increase continues back up to 100%.

This short-term impact could push some economies that are linked to China into technical recessions. The main countries in the firing line are the Eurozone and Japan. Both have flirted with recession over previous quarters and with such low activity being present in this quarter due to the virus; we believe they may fall into a technical recession moving into quarter 2. This has generally been priced in by markets and growth should pick up once the transitory effects of the virus are eliminated.

Is fiscal and monetary expansion likely?

The Federal Reserve has enacted a rate cut today with other central banks being priced in to do so over the coming weeks. The Reserve Bank of Australia has already cut rates by 25 basis points to stimulate their economy further. Many economists are also signalling stimulus packages by global governments to help provide ballast to their respective economies. The Chinese government has already started its own stimulus operation and Hong Kong has engaged in ‘helicopter money’, supplying large amounts of cash to its citizens.
Some investment firms are calling for more aggressive action, with Goldman Sachs for example looking for 100 basis point of Fed cuts in total and an imminent 50bp cut this month which has just been actioned. Any stimulus will help to provide the demand side of the economy some relief which will help the recovery moving into the second half of the year. We are focused on the type of stimulus that will be provided as we understand the economy is very late cycle and large amounts of central bank stimulus has been enacted. This does reduce the effect that further rate cuts can provide. Fiscal stimulus by governments should help to relieve this somewhat.

How to invest in such troubled times?

We believe the key to navigating these types of environment is to look beyond the short-term turbulence and reaction in the markets and determine what economic and market impact the virus outbreak will have on the medium to longer-term. In the very short-term markets are likely to move on daily news flow as uncertainty continues to dominate until concrete data points are released. Here at MAIA we do not want to time events like this as we could get it horribly wrong. Instead, we focus on the data and look for where we can add performance and return in the longer term, while providing defensive attributes from other asset classes.  For the long term we will continue to focus on investing in a range of assets that provide the best opportunity to outperform their benchmarks. Our current views on asset classes are below:

• Equities: For the long term we still believe equities from an active perspective provide opportunities for investors. In the shorter-term, earnings and prices will be hit. However, as we have recently witnessed, markets have already started to price in the effects of the virus on global economies and businesses. If it can be contained, overtime equity markets will recover. We continue to focus on the US and UK as overweight’s and post the virus outbreak look to increase our holdings in Emerging Markets and Japan as the valuations look attractive but currently too many risks are present to be more than a neutral weighting. Our equity holdings are diverse across geographies, market caps and style. This means diversification is present within our equity holdings.
• Fixed Income: We continue to use fixed income as a diversifier to our equity holdings. Fixed income spreads are tight and government bond yields have fallen significantly in the most recent sell off with many believing interest rates will get cut further. For the longer term, our views are neutral on fixed income as we understand the risks present when spreads widen, and yields rise once again. We prefer to utilise strategic bonds where the managers have scope to allocate to different fixed income dependent on the underlying market conditions. Income will be key as capital appreciation in the longer term will be lower than in the recent past.
• Alternatives: Gold and Infrastructure continue to be overweight in our portfolios, as does Defined Return assets. All these provide diversification to fixed income and equities. These types of assets have provided some defensive qualities in the recent sell off plus alpha in previous rising markets. Gold is an especially prudent investment now with central banks looking to cut interest rates further. Gold outperforms in interest cutting cycles and so should continue to provide positive returns moving forwards as more cuts could be made by central banks throughout the year.

In conclusion

What we know so far suggests the right approach is to keep a steady hand and avoid selling amid short-term turbulence. Global doctors and officials seem to be very complimentary of the way Chinese authorities are handling the outbreak. But the coronavirus episode will damage global growth, company earnings and global economies over the next few quarters, and the continued deceleration of global activity together with the attendant risks of a more severe scenario suggest a diversified portfolio is key. Longer term growth prospects should improve once the virus epidemic is controlled and fiscal & monetary stimulus gets implemented further. Until then alternative and fixed income assets will help to provide defensive qualities alongside our long term allocation to equities.