-The magnitude and duration of the economic impact of the COVID 19 – is unknown at this point.
-The virus’s impact on earnings and economic growth will be measurable, with slower-growth in the U.S. and technical recession in Europe and Japan.
-Risk control assets have and will continue to provide robust and dependable diversification.
-Now is not the time to make significant moves in your portfolio.
Global economies and markets continue to react to the spread of COVID-19, or coronavirus, this week as investors, central banks and governments struggle to ascertain the potential short- and long-term impacts from the virus. Underlying the financial challenge is the global medical challenge: unknowns regarding both the nature of the virus itself as well as the world’s capability in managing it.
1. Why have U.S. equities underperformed their global counterparts?
Since their February 19, 2020 high, U.S. equities have been harder hit than developed market ex-U.S. and emerging market equities.* One reason for this relative performance has been valuations. Whereas non-U.S. equities entered this period with greater earnings and fundamental vulnerabilities, U.S. equity valuations entered it with higher valuations relative to history. And when sentiment changes at high valuations, it is common to see a rapid repricing of risk. Also, interestingly, non-U.S. markets had an unanticipated tailwind from a weakening U.S. dollar. While the greenback had been strong coming into the year, recent weakness took hold as global interest rate differentials narrowed and the markets became more convinced of pending monetary policy easing. The trade-weighted dollar (DXY) has fallen over 2.7% since its Feb. 19 level.
However, while U.S. equities have underperformed during this recent period of extreme volatility, they still hold the top spot on a year-to-date basis.
2. Will Fed rate cuts and other monetary policy actions make a difference? How can they help?
Monetary policy can only do so much. Clearly, it cannot cure a virus and is constrained by already-low global interest rates. That said, it can make a difference by loosening financial conditions. Over the last week, we have seen significant tightening in financial conditions, including wider credit spreads and falling equity prices. Stemming this trend can help restore investor confidence and alleviate pressure on companies with leverage – particularly small- and medium-sized businesses. The Fed delivered a 50 basis point cut to the Fed funds rate on Tuesday morning– a move that was widely rumored on Friday afternoon and likely lent fuel to Monday’s equity rally. Market reaction on Tuesday was decidedly different, as investors interpreted the cut as a sign that the Fed was extremely worried about the economic outlook.
In attempting to offset an exogenous shock like the coronavirus, easier monetary policy is inadequate in isolation. Governments will likely also need to enact fiscal stimulus to stabilize the economy. In certain countries, including China, Hong Kong and Taiwan, such measures have already been announced, and in the U.S., stimulus, particularly in the form of healthcare spending, seems likely.
3. What are stock markets pricing in? What are bond markets pricing in?
The answer to this question is changing by the minute, as risk continues to be repriced with the latest news. As of Tuesday, global stocks were in correction territory after a brief respite on Monday, stock market volatility was near its highest level since the financial crisis, and the short-end of the yield curve was inverted. We also saw the U.S. 10-year Treasury yield fall below 1% – a historical low. All of this reflects a high-anxiety flight-to-quality as well as a deteriorating growth outlook. We expect prices will likely continue to fluctuate dramatically as the market attempts to gauge the magnitude and duration of the virus’s ultimate impact.
4. What does all of this mean for investors’ portfolios? What actions should they take?
For most, stay the course. This is a time to be very careful about making moves in your portfolio – as demonstrated by volatility over the last week, during which the stock market rose and fell dramatically with news and shifting sentiment.
We work in a framework that anticipates market stress and is always prepared for the unpredictable. Most importantly, build portfolios that reflect each client’s unique risk tolerance through allocations to high quality fixed income – or “risk control” assets – which for our clients serve as a reserve to fund near-term goals during market downturns. These assets have recently and will continue in the weeks and months ahead to serve their important purpose of dependable diversification.
5. Let us Hear from RIA Firms on What Are You Doing To Combat this COVID 19 Virus with their Clients?
Tell us what are you doing for your Clients and What type of Investments are you advising them to position in their Portfolio’s???
REO Capital – Blog