We are only beginning to see the full impact of the coronavirus on economic activity as governments ‘lock down' significant portions of the economy to stop the virus' spread. In the coming months the true scale of the shutdown on global economies will become apparent, but it does not appear likely that a recession will be avoided. The question is rather how deep and for how long we will be in a recession.
Markets have responded to this unprecedented global supply and demand shock with very high levels of volatility, including significant sell-offs of major asset classes. In addition, oil markets already struggling with the virus-related demand shock were hit with a supply increase as OPEC failed to agree on cuts to production and a price war commenced. The speed with which the selloff occurred, and also the uniformity of the sell-offs on the worst days - where safe havens sold off with risk assets - has been historically significant. Against this backdrop, we see defensiveness as a priority over trying to time a bottom in asset prices.
From the beginning of the year until 21 February, the market's ‘fear gauge' tracking the 30-day implied volatility of the S&P 500 - the Chicago Board Options Exchange Volatility Index (VIX) - was sedated even as news of the coronavirus broke and a market selloff ensued in late January and early February. Following this brief period, volatility retreated, and markets again touched all-time highs.
However, as news of the spread into Europe and the United States became clear, markets sold off, with the S&P 500 losing one third of its value between 19 February and 23 March, while the VIX spiked to all-time highs in the space of only three weeks, breaching the peak seen in the Global Financial Crisis.
The uniformity of selloff has also been concerning. Demand for cash, preferably in US dollars, has seen traditional safe havens like US Treasuries and gold selloff along with risk assets on the worst days of market volatility. The requirement for diversified approaches, even within defensive allocations, is of primary importance.
Can comparisons be made?
It is also difficult to compare the recent selloff with previous market events for other reasons. The global financial crisis was primarily a crisis of the financial sector which called into question the viability of the banking system, but which then had knock-on effects for the economy. But this crisis is different, and the non-financial corporate sector is, for now, bearing the brunt of the impact of the economic shutdown required to help contain the spread of the virus.
Policy responses have been swift, and while it seems only economic ‘lock down' can stem the spread of the virus, monetary and fiscal policy can help to ease conditions for companies struggling with cashflow issues as demand falls. Monetary policy is helping the funding markets and keeping debt-servicing costs low for the corporate sector, whilst helping to drive government borrowing costs lower.
Fiscal measures have also been swiftly deployed, as governments the world over look to support their populaces and businesses in face of this unprecedented economic shutdown. The figures for which have been eye wateringly large, such as the US $2trillion stimulus, underlining the seriousness of the situation. While not a panacea for the virus itself, policy responses are a positive, and allow elected officials to have a buffer for helping consumers and the non-financial corporate sector deal with the effects of the ‘lock down'. In addition, supportive policy will act as a tailwind when the global economy emerges from the worst of this public health crisis.
In the Fidelity Multi Asset Open range, we continue to focus on the defensive shape of the funds in light of the major intraday moves we have been seeing. Gold remains a core anchor in this regard, with exposure to both gold mining companies and physical gold, with a bias towards the latter, which is less volatile. While gold has declined at times of peak volatility during March, we attribute this to technical factors, and our thesis we believe is still positive on the asset over the medium term. In addition, we have reduced our tilt towards emerging markets as the onset of the virus is only recently making its presence felt in these regions, namely Latin America and Africa.
Alongside this, we have concerns surrounding the risk of a second wave of cases in China, as the country starts to return to work and social mobility increases. Our allocation to a long-volatility strategy, designed to profit from situations like we have seen so far this year, has also been an effective hedge, and highlights the importance of the work carried out by our dedicated Alternatives analysts within our Manager Research team. In terms currency positioning tilts towards defensive currencies such as the US dollar and Japanese yen also contributed towards helping the funds weather some of this unprecedented market volatility.
It's a waiting game
While volatility has receded somewhat and markets are searching hard for good news, the true impact of the economic hit remains unclear.
On the positive side of the ledger, unlike in the case of natural disasters such as floods and earthquakes, capacity has not been affected in this case and should be able to bounce back quickly once demand returns. We have seen tentative signs of this happening in China. But the virus' spread continues with concerning signs in previously unaffected areas like India, and risks of a second wave in China that can't be ignored.
Uncertainty over the efficacy of policy responses is likely to continue in the coming weeks and months. We have seen assets behave in unexpected ways during this period and continue to take advantage of the Fidelity Multi Asset Open range's flexibility to allocate across regions and asset classes to diversify our exposures. Given this environment, downside protection is of primary importance, and this remains our focus over trying to time the market hitting bottom.
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