Since the end of February, the steps taken to stem the Covid-19 outbreak have proven relatively ineffective and the authorities have no visibility on the actual economic impact of the virus, leaving the financial markets mired in uncertainty. Market sentiment does not currently reflect a clear directional bias, and the accommodative monetary policies implemented — by the US Federal Reserve (Fed) and the European Central Bank (ECB) in particular — are no longer enough to reassure investors. It's an open question if the budgetary/fiscal stimulus policies outlined will be the next upside catalysts, or if will we have to wait for a significant improvement in health before there's a rebound.Since the end of February, the steps taken to stem the Covid-19 outbreak have proven relatively ineffective and the authorities have no visibility on the actual economic impact of the virus, leaving the financial markets mired in uncertainty. Market sentiment does not currently reflect a clear directional bias, and the accommodative monetary policies implemented — by the US Federal Reserve (Fed) and the European Central Bank (ECB) in particular — are no longer enough to reassure investors. It's an open question if the budgetary/fiscal stimulus policies outlined will be the next upside catalysts, or if will we have to wait for a significant improvement in health before there's a rebound.
In recent weeks, there has been a widespread sell-off in the equity markets and volatility has skyrocketed. The S&P 500 and Stoxx Europe 600 suffered losses of around 12%-13% in the 20‑28 February period while the VIX exceeded 40 points.
On Monday, the plunge in the equity markets gathered pace after Russia refused to fall in line by rejecting the new OPEC agreement on oil production. To retaliate against Moscow, Saudi Arabia confirmed its intention to open the floodgates and start a price war.
This sharp and massive increase in the supply of crude oil on the market was particularly unsettling since demand has been hard hit by the Chinese (and global) economic slowdown since the Covid-19 outbreak began.
Against this backdrop, WTI and Brent prices plunged nearly 25% on Monday, bringing the leading oil stocks down with them. The US majors and E&Ps, which are much more sensitive to oil prices due to higher extraction costs for shale gas, were particularly affected. Energy drove the VIX to record levels and caused a number of temporary suspensions of trading on the US markets. That day, markets closed down 7,5% in both Europe and the US.
In terms of the breakdown of the equity sector allocation, our recent repositioning — including our move to neutral on utilities — worked in our favour, while electricity and water suppliers proved resilient in the downturn. Although we are not immune to the sell-off, the slight decline in multiples presents some nice opportunities to fine-tune the consolidation of our positions in this sector. The sectors on which we reiterated our positive stance — communication services, real estate and healthcare — also recently had a nice run. Moreover, Biden’s comeback against Sanders in the Democratic primary in the US also prompted investors to remain positive on the healthcare sector.
Contrary to expectations, this sell-off did not benefit assets generally considered defensive.
The price of gold, the ultimate safe haven, fell at the end of February and never exceeded USD 1.680/oz. The usually more stable dollar has depreciated by nearly 4% against the euro since 20 February. Only government bonds, and US Treasuries in particular, seem to be truly trending significantly higher.
The already very low yields on the European bond markets at the end of the year have not put us off sovereign debt. Support from the ECB, a strong driver of demand, and lower-than-expected inflation justified these levels. We were therefore able to take advantage of the fall in rates that followed the spread of the coronavirus.
On the credit side, risk premiums were very compressed before the epidemic grew. The ECB’s monthly buybacks explain this state of affairs, especially as many investors, like insurance companies, have gravitated towards private-sector debt to achieve higher returns due to their rate constraints.
Our mixed view of the economy, combined with these very low risk premiums, has pushed us towards the private debt of defensive — and therefore non-cyclical — companies with sound financial balance sheets. We have thus been able to mitigate the impact of the rapid expansion in risk premiums following the epidemic.
In addition, a decorrelation arose at the end of 2019 between the risk premiums of private debt and leading economic indicators, which also pushed us towards debt that is eligible for ECB buybacks. We believe the buy-and-hold nature of this debt means it is less volatile and presents a lower downside risk.
On the US markets, and more specifically on sovereign debt, we are positioned for cuts in short-term rates. We had forecast this scenario last summer due to excessively contained inflation, indicating asymmetrical probabilities for changes in US rates. As a result, our positioning benefited greatly from the expectation — which was subsequently confirmed — that the Federal Reserve would cut rates in response to the economic impact of the coronavirus.
While the bitter taste is lingering, let's not forget that every complex situation presents opportunities. In this context, we expect to use liquid funds to take advantage of the opportunities presented by this market environment, as some stocks are trading at valuations that could prove attractive to long-term investors.
To sum up, our investments have generally outperformed their reference indices due to the defensive positions taken several months ago, as well as our recent responsiveness. We believe that current valuations, in particular on the equity markets, present an opportunity to build sound bases for medium- and long-term investment.
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This document was produced by the Private Banking Unit and BCEE Asset Management. The drafting of this document was completed on 03 April 2020 at 10:00 pm.
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