Crisis in Confidence Roils Financial Markets
When it rains, it pours. In an extremely erratic start to the week, financial markets are in full-on risk-off mode. Panic manifested itself throughout the marketplace over the weekend in the wake of accelerating cases of the coronavirus in the developed world, while the global oil price war has added to a fragile and panic-stricken backdrop that’s already reeling from the COVID-19 outbreak.
Specifically, the dramatic breakdown of talks between OPEC and Russia on Friday prompted Saudi Arabia to launch a price war, with US shale producers getting caught in the crossfire. It would seem that fears about the global oil demand backdrop have also wrecked havoc on decision-making, with Saudi Arabia shocking the market by announcing sharp price discounts in an attempt to grab market share from their competitors, while also stating that it plans on boosting production. Meanwhile, the potential disintegration of OPEC and the sharp pullback in crude prices has raised the risk of credit issues and created some imminent pain for energy producers in general. Adding to the risk averse tone was news of the rapid spread of COVID-19 cases in the US and across Europe, with efforts to contain the virus dampening global demand prospects as large events get cancelled and mobility restrictions (and fear in general) keep people at home.
This crisis in confidence has sparked a horrendous financial market response. Equity markets are in full-on correction-mode, with the latest spike in volatility fuelling forced selling by exchange traded funds, targeted volatility strategies, and all-weather funds – which has ultimately amplified the downward move in stock prices. Meanwhile, global bond yields are in free-fall as investors seek a refuge from the storm. Not surprisingly, oil currencies such as the Canadian dollar, Norwegian krone, and Mexican peso have slumped precipitously, while traditional safe havens such as the Japanese yen and gold have thrived in the tumultuous trading environment.
Investment Strategy Implications
While we acknowledge that our current asset allocation strategy is on the wrong side of the trade given heightened levels of fear in the marketplace, our base case for 2020 continues to call for an eventual rebound in growth and a corresponding recovery in risk assets. Assuming the virus is contained in the coming months, exhaustion around coronavirus headlines should help to alleviate pressure on both risk assets and the global economy alike, with our expectation for a comeback in growth amplified by the abundant liquidity backdrop at hand (not to mention the stimulative impact of lower oil prices for the global consumer). Indeed, recent disorderly moves in financial markets have reinforced the case for aggressive fiscal support in conjunction with easier monetary policy – which should help to boost confidence, stock prices, and bond yields. As such, we would resist the temptation to sell into panic/weakness and await increased clarity on the status of the viral outbreak (peak episodes outside of China) and the magnitude of the fiscal and monetary response before altering our longer-term outlook.
FYI: Our five key pillars continue to point towards a modest overweight in stocks versus bonds:
- FUNDAMENTALS: NEUTRAL
- LIQUIDITY: VERY POSITIVE
- VALUATIONS: NEUTRAL
- TECHNICALS: NEGATIVE
- SENTIMENT: POSITIVE
Vice President and Portfolio Manager, Global Asset Allocation