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How coronavirus is shaping our views on financial markets

We know the recession is going to be severe, we are not yet clear how quickly that recession will last. But what that has meant for financial markets is a continuation in volatility.

Equity markets for example, have definitely priced in some euphoria as the daily case count begins to slow and we anticipate that over the next 3 months, volatility is going to remain. There will be some strong days and some very poor days as equity markets start to rationalise between the slowing daily case count and the increasing evidence we have of the economic impact being increasingly severe. Indeed, particularly in the US, we are going to learn a lot this quarter as US companies report their earnings for the first quarter of this year but more importantly, during that reporting process provide their outlook for the year ahead. Only then will we get a sense of what those corporations are battling with and will begin to price in the severity and impact this will have on the economy itself.

So we think equity markets will continue to be volatile over the next three months. That being said, from a government bond perspective, we do think central banks have been very successful in capping bond yields, keeping bond yields low, and that has given us some confidence that government bonds are a source of protection for the portfolio and that at this stage, and over the next 3 months, there is a huge appetite from central banks to contain bond yields to ensure that bond yields don’t spike high and bond prices don’t dip low. Government bonds look to be well contained by central bank policy.

Corporate credit as an asset class is one that has gone through a significant shock and stress over a six week period. We think there is a second wave of that to come. Over the last six weeks it really wiped out three years of gains in the high yield market, for example, we think there could be a second wave as corporate credit is downgraded as defaults start to come through. At some stage there is an opportunity to begin to allocate to corporate credit, both the investment grade and high yield space. We don’t feel we are there yet but that is an area that we’re looking for as one that we can take advantage of over the next two to four months in terms of beginning to build some exposure out of cash into the corporate credit markets.

At the same time as equities remain volatile, the focus for us over the medium term continues to be on inflation. It’s really important with the 12 month and beyond time horizon, to look at whether or not this concoction of both fiscal stimulus and monetary stimulus is going to have a significant impact on inflation. That will be something that really hasn’t manifested itself over the last three decades or so and will identify quite a regime shift in terms of the way that financial markets price in that inflation. So that’s an area of key focus for us and we will continue to provide updates on that as we work through that analysis ourselves.