By Lorenzo La Posta
When markets panic, the only investment mantra I believe in is “breathe, think, act”. Sell-offs can provide fantastic buying opportunities, but elevated risks often accompany them. After the recent sharp drop in global equities, is this now a good entry point or is this a falling knife we do not want to catch? Are markets overly worried about coronavirus or are more negative prospects not yet priced in? We believe that, at these levels, risk assets offer attractive long-term expected returns, but more volatility is likely to come.
Two months after the first reported cases of coronavirus, there have been around 112,000 confirmed infections and 3,900 deaths worldwide. People are understandably worried but, bearing in mind that most infected people (those with mild symptoms, which accounts for around 80% of estimated cases) are not accounted for in these numbers, the “effective fatality rate” appears to be a much smaller – 0.7%.
As fears of a global pandemic mounted, global equities experienced their worst week since the global financial crisis and the fastest correction in history, with US and European equities falling -11.5% and -12.3% respectively. With markets tanking and investors seeking optionality and insurance, typical defensive assets delivered downside protection at different times: the gold price touched an intra-day peak of +2.8% but lost 6%; the Japanese Yen rose steadily and gained +4% against the US dollar.
Real economies are suffering too. In an effort to reduce contagion, many countries have been restricting travel, cancelling large public events, suspending public transportation and quarantining people. As previously discussed, the predictable effects of such measures have been a short-term decline in economic activity with a deterioration in consumption, growth and investor sentiment. Looking forward, we believe there are two scenarios likely to take place. In the more negative scenario, infections increase in western countries and economies hit the brakes further to prevent contagion. Here, a synchronised global slowdown taking place in an already weak, mature business cycle could increase recessionary fears and spark a further sell-off. In a more positive scenario, western economies take advantage of the lead time and cope better with the outbreak with minimal economic disruption. Also, as China restarts its operations and global governments and central banks plan for fiscal and monetary stimulus, economies recover faster than expected and oversold financial markets reprice as a consequence. There is elevated uncertainty out there and it is not easy to evaluate which outcome will play out, nor what is priced into current market valuations, but we are currently leaning towards the latter scenario.
In such a volatile environment, a diversified portfolio is the most efficient way to achieve your long-term investment outcomes. Breathe, think and act without letting panic take the lead.
Lorenzo La Posta is an analyst at Momentum Global Investments
- 5 Mar, 2020