Coronavirus update: Volatility to remain high for the time being

Central banks and policymakers this week have responded quickly and resolutely to the threat posed by the SARS-CoV-2 coronavirus. Their efforts have lifted sentiment a bit on the financial markets, but there is still plenty of uncertainty about the future course of the public health crisis and the severity of its (economic) effects. Stock-market volatility therefore looks destined to stay elevated in the days ahead. With well-diversified portfolios, we feel well-equipped to weather the volatility.

The virus and its repercussions continue to spread

The SARS-CoV-2 coronavirus remains the topic of the hour and continues to dominate front-page headlines. The number of infected people around the world has since nearly reached the “sound barrier” of 100,000. The epidemic, in the meantime, has spread to more than 80 countries, including Switzerland (119 confirmed cases*) and Liechtenstein (1 confirmed case), and the death toll worldwide has climbed to over 3,000. Although an end to the public health crisis in not in sight yet for now, its impact on the world economy is becoming ever more visible. For example, the Chinese purchasing managers’ index, a reliable leading indicator of economic activity in the Middle Kingdom, recently fell to its lowest reading on record, confirming our expectation of very feeble GDP growth for the first quarter. The economic growth outlook continues to dim also outside China. The crisis is bound to put a dent in economic output this year not just in the manufacturing sector (due to supply-chain disruptions), but also in the service sector (due to canceled events and trips). Growth projections for 2020 accordingly have been lowered further in recent days. The OECD cut its world GDP growth forecast for 2020 from 2.9% to 2.4% and even sees global economic output slowing by half in a worst-case scenario.

Volatility to stay high for now
Recent lows may get retested

MSCI World Index

Resolute response by central banks…

Faced with rampant uncertainty on the part of financial market participants and economic actors, the US Federal Reserve responded on Tuesday by slashing its policy rate by 50 basis points. The size of the rate cut was surprising. Very rarely has the Fed ever taken such drastic action; the last time it did was in 2008 during the throes of the financial crisis. Lowering interest rates cannot cure a virus, but the injection of money by the Fed nevertheless does have a beneficial impact on financing conditions for businesses and on investor sentiment. The latest move by the Fed once again illustrates just how sensitive US central bankers are to developments on the stock market and how strongly they react to “demands” made by the futures markets, which in recent weeks had increasingly been calling for and pricing in a big rate cut. At the moment, the futures market is pricing in another half-point reduction at the Fed’s next policy meeting on March 18. If the coronavirus situation doesn’t appreciably improve by then, the Fed looks set to cut rates at least by 25 basis points. Even though one shouldn’t underestimate the uplifting effect that renewed rate cutting has on sentiment, which should pay off in the medium term in the form of stabilized stock prices, we nonetheless view the recurrent move to rescue the markets through monetary policy very critically because the Fed may then lack the monetary tools it needs to confront the next economic crisis – it in any case will hardly be able to further loosen the interest-rate screw.

…and policymakers

Support for the war against the coronavirus was also chipped in this week on the political front. The World Bank and the International Monetary Fund (IMF) rolled out a combined USD 62 billion loan and grant facility to aid developing and emerging-market countries in coping with the crisis. In the USA, the House of Representatives passed a USD 8.3 billion emergency bill to fund efforts including vaccine development and measures to prevent the spread of infection. European policymakers in many countries are also considering fiscal policy measures and are taking various actions to combat the coronavirus crisis.

We don’t expect the financial markets to settle down sustainably until the number of new infections decreases noticeably.

Diversification remains the name of the game

Financial-market volatility has stayed very high in recent days. The US equity market, for instance, has registered daily fluctuations ranging from 3% to 5%, and the CBOE Volatility Index (VIX) has remained very elevated with readings consistently above 30 points lately. However, equity markets have pulled away somewhat from their earlier correction bottoms. By Thursday evening, the S&P 500 Index had climbed back 6% and the Swiss Market Index 4% from their respective February 28 lows. But both indices are still far off their year-to-date highs (S&P 500: –12%; SMI: –10%). A look at the various sectors since February 21 reveals a wide performance spread given the short time span. The biggest loser is the energy sector (–17%**), which was hurt by a massive selloff in crude oil. Consumer goods and utility stocks, in contrast, exhibited relative strength, with both sectors losing only around 4%. The additional rate cuts by the Fed make these high-dividend sectors even more attractive.

The price of gold posted significant gains again this week as it especially benefited from the Fed rate cut. The yellow precious metal is now up 9% year-to-date. The prospect of even cheaper money has also benefited real estate funds (+5% YTD). In our portfolios we have overweighted both asset classes relative to their weights in the strategic asset allocation. Swiss stocks, which we have overweighted as well, have also held up relatively solidly thus far in the market correction.

Gold is a winner of the crisis
Swiss stocks are also holding up relatively well

Year-to-date performance of asset classes

We don’t expect the financial markets to settle down sustainably until the number of new infections in and outside China decreases noticeably. That should then mark the apex of the crisis at least from the perspective of market participants, who can then start looking ahead again. Until then, though, we expect to see persistent high volatility, which we feel well-equipped to weather given the way our portfolios are positioned. An analysis of comparable stock-market corrections in the past suggests that a retest of the February 28 lows is not unlikely, but that could open up further tactical investment opportunities. Structured products, for instance, offer much more attractive conditions in a climate of elevated volatility.

*Number of infections as of March 6, 2020, 11h00

**Market data as of end of March 5, 2020