How can investors navigate the coronavirus outbreak?

Equity markets have fallen very sharply this week, reaching double-digit drops for many markets. This is principally (but not exclusively) due to fears of a COVID-19 pandemic as infections spread to different countries. The market reaction is determined by what authorities tell us. The overreaction (arguably) of authorities in certain countries; locking down two northern provinces in Italy, closing schools in Japan and Hong Kong, and declaring a state of emergency in the Japanese island of Hokkaido, is feeding a market panic sentiment.

There is the risk that other countries will follow suit. Most other European countries are on the cusp of a significant rise in infections, and may be tempted to take strong steps to stop the spread. The US appears to be behind reality, with a tiny number of people being tested compared to other countries and hence, probably, little knowledge of how bad things can get. We have to expect that the news from western countries will not get better in the short term, even when Chinese activity starts to improve as people go back to work.

Technically, stock market corrections (or falls) have a life of their own and it is likely we will see a rebound in risk markets followed by another fall. This often challenges the low of the correction until the market recovers durably from the bottom. We are, however, at the mercy of the news flow on COVID-19, which could extend the timeframe of any correction somewhat – particularly if various countries report their infections at different rates and take steps that could amount to overreaction. Ultimately, it is extremely difficult for authorities to strike the right balance between trying to protect public health and trying to keep the economy going.

We may also inevitably get growth data for different countries that put them into a technical recession (two consecutive quarters of negative growth). The question is, how long the slowdown will last and how quickly it will recover. In that respect, we are likely to have the 'cavalry’ coming in the form of the central banks and government budgets. The US Federal Reserve (Fed) is expected by markets to announce one or two cuts in interest rates soon. Other central banks may add their weight to the easing process, although many have much less ammunition than the Fed. This should help sentiment.

The big help to sentiment, however, should come from China. China will almost certainly stimulate its economy through monetary policy and fiscal spending with a potential ‘bazooka’ on infrastructure. Bear in mind though, any stimulus on infrastructure can only come once the virus situation has been sorted; it does not make sense to spend money on projects when the country is in lockdown. This will probably delay the announcement and the effectiveness of any central bank moves in the US, Europe, the UK, Japan, and so on.

There is a potential risk that the US economy does not recover fast enough to produce the electoral outcome that the markets want, namely the re-election of President Trump. We are still many months ahead of this potential concern but will keep it in the back of our minds.

For the time being though, it seems risky to join in the selling spree in risk markets, as a recovery is much more likely than a deeper crisis. Authorities may panic markets with health protection steps but they will want their economy to recover as soon as possible afterwards. A ‘v’-shaped recovery in markets is therefore the most likely scenario at this juncture, and trading the ups and downs of equities could be very tricky. It therefore seems more sensible to sit on existing risk positions rather than joining in the panic. We will obviously revisit these views as new information comes in.

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