Central banks: easier ever after
A sobering few days has seen the global number of Covid-19 deaths rise above 16,000, with the total number of cases now approaching 375,000. Amid the rapid spread of the virus, both the Federal Reserve and the European Central Bank have signalled a “no limits” approach to shoring up their economies and financial conditions. Last week ended with the Bank of England cutting rates to 0.1%, meaning that US and UK macroeconomic policies are now at their loosest levels in over 25 years.
European equities: what will weather the storm?
Europe has assumed the unfortunate mantel of the epicentre of the Covid-19 pandemic. Our European Equities team observes that investors have become even more defensive over the past week, which has caused market breadth to narrow sharply and has benefited mega-cap names in consumer staples and healthcare.
The extension of a short-selling ban across multiple European markets – France, Belgium, Austria, Greece, Spain and Italy – may have stemmed further market falls. However, there was still significant fallout in response to worsening news about the spread of the virus.
Our European portfolios are biased towards quality companies, with a focus on strong balance sheets and free cash-flow generation – something we think is essential in the low-growth environment we face over the medium term.
US SMID: a focus on fundamentals
The US SMID team points out that the sell-off is indiscriminate and that stock prices are a poor reflection of a company’s current or long-term intrinsic value. This has created an opportunity to buy attractively valued companies with healthy balance sheets and diversified business models.
Emerging markets: recovery in China
Meanwhile, our Global Emerging Markets (GEMs) team notes that the spread of the virus to India, South East Asia and Latin America has sparked similar shut-down measures seen in Europe and the US. This has led to further disruption across supply chains, such as the shuttering of two of the world’s largest copper mines in Peru.
The GEMs team also points out that China appears to have turned a corner, which can be see by strong market performance in Hong Kong and the mainland. The government has initiated a strong policy response to the epidemic, lowering the reserve requirement and provision of a medium-term lending facility, as well as conducting repurchase-agreement operations.
Beijing also continues to prioritise critical national infrastructure projects, although it has stopped short of carrying out major fiscal stimulus. Domestic stock managers have also been discouraged from selling there, which may act as a further floor on market movements. Encouragingly, economic activity continues to pick up, which has allowed supply chains to resume orderly operations.
Fixed income: digging deep for dislocated credits
Our Credit team notes that last week saw some of the largest moves in credit spreads since 2008. The iTraxx Crossover, a European high-yield credit-default swap index, has widened from about 200bps to 710bps since the start of the crisis, while CDX High Yield, the US equivalent, has moved from 230bps to 800bps.
We also saw the sell-off in fixed-income assets move to government bonds. This suggests that investors are struggling to find liquidity and are forced to sell what they can to raise cash, limiting the usefulness of sovereign debt as a safe-haven asset. This could also represent fears that the mounting cost of government support packages may create problems for European economies.
Sales of emerging-market debt started to increase significantly over the week, as investors pulled large amounts of capital from the asset class. The team also notes that rating agencies have been quicker to react to changing fundamentals than in 2008: year-to-date, there have been twice as many downgrades than upgrades as the outlook worsens for many borrowers.
Yield curves have flattened significantly during the crisis, which has heavily impacted shorter-duration credits. For higher-quality bonds which survive this period, this is will be a temporary phenomenon and will revert to normality through either a steepening of credit curves or a move to par as they mature.
As yields rise, there is no longer an issue with negative convexity as bonds are now trading well below their call prices and extension has materialised. In this environment, our team is actively scoping out opportunities to invest in credits that have become dislocated from their underlying fundamentals.
Volatility: can the uncertainty continue?
There may be an end in sight to the extreme market volatility that we have witnessed in recent weeks. Our Multi Asset team notes that these heightened levels of volatility – the CBOE Volatility Index soared to a record high last week – have started to subside. As market fatigue sinks in, the new reality will become normalised and some of the uncertainty should clear as worst-case scenarios become priced in.