February 28, 2020
This week, what began as a spike in risk aversion, has proliferated into a panic-driven sell-off in global equity markets. With the correction having brought about more reasonable equity valuations, we are compelled to take the financial opportunity to increase our exposure to equities in both the US and China, bringing our neutral stance on equities to a slight overweight.
In Low risk profiles, we will increase exposure to US equites by 2.5%.
In Medium risk profiles, we will increase exposure to US equities by 3% and to Chinese equities by 1%.
In High risk profiles, we will increase exposure to US equities by 3.5% and to Chinese equities by 1.5%.
We will finance these purchases by exiting positions in the riskier tranches of the fixed income market.
Rationale / Background
Coronavirus, originally assumed to be a China-centric problem, has become a global problem. In Europe, Italy has quarantined some 100,000 people in order to prevent further infection, while a number of cases have popped up around the globe, most predominantly in Japan, South Korea and Iran. With no cure nor vaccination currently available, the human impact is severe and regrettable, and it is impossible to predict when the number of cases will peak.
However, with the internet and social media enabling panic (not always based on facts) to travel faster than a pandemic, we feel markets have abandoned fundamentals, selling-off by more than current economic conditions merit. Due to supply chain disruptions, business closures, travel cancellations and a wait-and-see stance amongst decision-makers, it is completely reasonable to expect that coronavirus will put a dent in first-quarter figures, perhaps having an even more prolonged effect.
This may even catalyse some ‘technical recessions’ in already-fragile economies (particularly in Europe). However, we do not currently believe in an actual, full-blown recession, especially with the US still exhibiting a fair amount of economic muscle. Fundamentals have always guided our investment strategy and when markets press the panic button, it is then when we should cling even more tightly to what has guided us, rather than losing sight of it.
On top of reasonable fundamentals to date and a benign earnings season, there is the upside risk of fiscal and/or monetary stimulus, as has already emanated out of China, bringing a lot of liquidity. Markets are already betting that the Fed will soon intervene (Fed fund futures now imply 3 rate cuts in 2020, with a 64% chance of one in April). In Europe where the monetary policy jar is not exactly overflowing, the epidemic could be the catalyst that sets the ball rolling on monetary stimulus – already the German Finance Minister has proposed a temporary suspension of the country’s Schwarze Null (black zero) budget policy. At the same time, Hong Kong is deploying helicopter money as part of its policy arsenal.
All in all, the sell-off can be explained by the embedded uncertainty, something that investors loathe. However, in witnessing the fastest stock market correction on record from the side-lines, with a neutral equity exposure, we took the market chaos as a short-term opportunity to add to our exposure.
Author: Group Investment Office