Quarterly Investment Outlook
Second Quarter

Created: 2020.04.06.

You will find below our March market review and our investment outlook

Market Review

The market correction that began in late February took on proportions not seen since the Great Financial Crisis in 2008 as it became clear that a COVID-19 pandemic was inevitable.

Making matters exponentially worse for the markets was the collapse in oil prices resulting from the Saudi-Russian price war. The massive de-risking and forced deleveraging by investors led to a contagion among all asset classes not seen since the Great Financial Crisis with cash being the only asset class left safe. Government bonds, investment grade and high yield credit have all shown significant signs of systemic stress, with echoes of 2008, during the recent sell off. Amidst this turmoil, bid/ask spreads hit levels not seen since 2008-2009. This volatility is likely due to heavy selling pressure rather than low dealer inventory.

The sell-off continued early last week despite government pledges of further fiscal support and central bank injections of economic stimulus, as countries moved into lockdown and closed borders or tightened border controls to contain the coronavirus outbreak.

The health crisis has moved into an outright economic crisis. The first data related to the virus spreading have been released. Albeit still very limited, they all confirm that the economic shock will be intense, exacerbated by the lock downs measures taken to fight the spreading of the virus. Business leaders’ confidence has plunged everywhere, in China, in Europe as in the US. Bankrupts and the unemployment rate start rising. Monetary policies coordinated with fiscal policy are the only solutions against the economic blow of the coronavirus. Major central bank responses have included rates near or below zero, a sharp rise in quantitative easing (QE), a revival of crisis programs such as Federal Reserve funding of commercial paper and primary dealers, and more. Confronted with the rapid deterioration of market liquidity, Central banks had to step up its measures. The Fed is said to have bought USD270bn Treasuries in only one week and announced an unlimited quantitative easing program. The ECB launched a massive Pandemic Emergency Purchase Program (PEPP) amounting EUR750bn. The worst seems to have been avoided, but the situation remains tense.

Governments are also coming to the rescue with massive packages. Yesterday, an extraordinary $2tn US stimulus deal has been agreed. This should provide economic relief to American taxpayers and businesses hit by the coronavirus pandemic. This package would be based on temporary payroll tax cuts, direct payment to households, funding for distressed sectors, delay for student loan interest payments, delay of households’ tax deadline until June.

These measures should help markets to avoid the worst and contained the inevitable economic recession of the first semester.

Investment Outlook

We know things are bad and getting worse, as evidenced by the now incoming economic and earnings data, but what we don't yet know is how long it will remain bad and how quickly the world can recover once the pandemic has been contained. Lockdowns work, but they will take time to do so, and in the meantime the decline in economic activity is going to be very significant. We are dependent now on the relative speed of the pandemic and the policy response.

To exit this crisis, we believe three conditions need to be fulfilled: Strong central bank support, government actions and inflection of virus progression. Monetary policy officials have provided facilities that should prevent financial markets becoming even more disorderly as they deal the massive winding down of risk. But they are also proving credit backstops for the private sector and giving governments space to expand fiscal policy which is more directed at supporting aggregate demand.

We are likely at least several weeks away from the peak rate of change in either COVID-19 cases or the resulting economic distress. With Italy now hopefully nearing the peak of the curve, Europe in the next 2 weeks and the US possibly 3-4 weeks behind, the growth rate in new cases in the World would start coming down in late April. These next weeks may well seem like an eternity.

While a short-lived recession is now in the price, such a negative outcome like in 2008 is far from being priced in. As a result, the capital preservation logic should continue to prevail for a while and equity markets should continue to roller coaster until investors get some visibility on the peak of the virus epidemic. Bottoming is a process, and virus-related uncertainty could continue to weigh on markets until the number of new cases outside of China peaks and the fiscal response becomes coordinated and forceful.

Diversification is more important than ever but is harder to achieve than usual, given that assets have been moving together. We keep a significant allocation to safe assets like cash, Swiss government bonds and gold.

We still see a fundamentally favourable backdrop for gold as the economic fallout from the fight against the spreading of the coronavirus should further strengthen safe-haven demand. Should the situation lead into a systemic financial crisis, gold should come back to its previous highs.

With spreads wide by historical standards, investment grade corporate credit becomes more attractive. In an environment of heightened stress and dislocation, a rise in defaults is almost assured at this point but high-quality names should be able to better absorb the financial hits looming. We will wait for better liquidity conditions to start to build investment grade corporate bonds positions.

Within equities, we need to have the volatility going down and a more advanced bottoming process to increase our equity holdings. Equities are struggling to find a bottom; this is a multi-step process. On the positive side, the irrational exuberance caused by the excess of liquidity since last October has been erased; a short-lived recession is already in the prices. A lot of fear regarding the COVID-19 epidemic has brought the valuation of equity markets more in line with macro fundamentals. The MSCI World is trading at 14x times 12M forward earnings and 15x for the S&P500. But earnings growth is still expected to be flat this year, while it seems EPS could easily contract by 10-15% at least. The repricing can continue for a while. We expect huge swings on financial markets in the coming weeks, as long as investors will not have visibility on the peak of the epidemic. We favour large quality stocks from defensive sectors like Healthcare, consumer staples. We found lots of these leaders in the Swiss market (Nestle, Roche, Novartis). We also like US technology stocks related to the cloud business and ecommerce stocks that can benefit from the current situation (Microsoft, Amazon).