Multi-Asset

COVID-19 pandemic fear creates speed bumps for stocks

Investors were spooked this week with a surge in new cases of COVID-19 outside of China, most notably in South Korea and Italy, causing a sharp selloff in equity markets and a freefall in government bond yields.
February 2020
  • Cases of COVID-19 have peaked in China and the situation looks contained within the province of Hubei. Economic activity is slowly resuming. However, news that the virus is spreading outside of China, notably in South Korea and Italy, caused a sharp equity selloff in recent days.
  • Monetary and fiscal response has been announced, but we’re expecting more, notably from the Fed and BoC as soon as March or April. The next couple weeks will be critical to see if significantly more cases are confirmed in Europe and North America. If drastic containment measures are employed, the impact on growth and profits will be more significant, but still largely transitory.
  • While we are closely monitoring the situation, we are maintaining our main portfolio tilts modestly favouring stocks to fixed income, with a small overweight to duration. We are tactically over-weighting Emerging Market (EM) stocks as we expect the fiscal and monetary stimulus to offset the transitory corona drag and should help provide a sharp economic and profit rebound later in 2020 and beyond as the tailwind of the Phase One deal continues.

COVID-19 pandemic fear creates speed bumps for stocks

Investors were spooked this week with a surge in new cases of COVID-19 outside of China, most notably in South Korea and Italy, causing a sharp selloff in equity markets and a free-fall in government bond yields. Meanwhile, the spreading of the virus in China appears to have peaked around February 5th (Figure 1), which is helping daily life and economic activity to gradually resume. The impact to global equity markets has been relatively even across regions following a strong negative reaction against EM stocks and commodity prices in late January. Warning from the U.S. Centers for Disease Control and Prevention (CDC) (Source: Bloomberg) added to the anxiety, while firms are increasingly ringing the alarm bell over the impact of the disruption on their Q1 revenues and cutting guidance.

Figure 1: China new COVID-19 cases

Source: World Health Organization (WHO) COVID-19 Situation Reports.

We are closely monitoring live measures of economic activity in China, from home sales to coal consumption (Figure 2 and 3). Consensus expectation is for China’s economy to recover by end-March ex-Hubei Province, and late April for Hubei.

Figure 2: China Home Sales

COVID-19 pandemic fear creates speed bumps for stocks - Figure 2 - China Home Sales

Source: CEIC, Wind, Barclays Research. Data as of February 21.

Figure 3: China Power Plant Coal Consumption (10k ton/d)

COVID-19 pandemic fear creates speed bumps for stocks - Figure 3 - China Power Plant Coal Consumption

Source: CEIC, Wind, Barclays Research. Data as of February 21.

The next couple weeks will be critical to see if significantly more cases of the virus are confirmed in Europe, and to see if the virus spreads to North America beyond a few isolated cases. If drastic containment measures such as mass confinement and quarantines are employed, which will have a magnifying impact on confidence, the growth shock could be larger, but yet still largely transitory. Although it’s difficult to estimate the drag the virus will have on global economic growth and profits, we are optimistically expecting a sharp rebounding process starting in the spring and into the summer, assuming the planet does not plunge into self-quarantines.

What does it mean for investors?

Fear of pandemic is a highly unusual and uncertain risk event for investors to analyze. Kicking off 2020, our positioning reflected a cautiously optimistic view of the world with a modest overweight to equities versus fixed-income, with a persistent preference for U.S. stocks, where growth and profits remain more robust. To hedge this moderately bullish view, we also have a small overweight to fixed income duration as we believe the bar for central banks to remove their dovish bias is high. Finally, our overweight to low volatility stocks is also helping us navigate turbulent markets more confidently.

Near term, we expect monetary policy to continue support financial conditions in a meaningful way. Fixed income markets are increasingly pricing for additional rate cuts by the Fed, which continues to have a substantial yield advantage versus most developed economies. After staying on the side lines, the Bank of Canada will have to join the easing party this year even though Canada’s slow growth is largely unrelated to the corona virus. Rate cuts may be coming as soon as March or April if upcoming business and consumer confidence signal softer growth in coming months or equity markets extend their losses.

In response to new developments regarding the virus and its impact on the global economy and earnings, we are maintaining our main portfolio tilts as we think the recent market reaction is exaggerated when considering a 3-to-6 month investment horizon. While the supply chain disruption from the containment measures are clearly delaying our expectations for Chinese growth to pick following the phase one deal, the upcoming fiscal and monetary response should help to ensure the corona drag is short lived and followed by a strong V-shaped rebound. For this reason, we are taking the opportunity to tactically overweight EM stocks and underweight Canadian stocks, which should benefit less from the rebound in global risk appetite.

Disclosures

Views and opinions have been arrived at by BMO Global Asset Management. The information, estimates or forecasts provided were obtained from sources reasonably deemed to be reliable but are subject to change at any time.

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