March 9th, 2020: from now on this date will be known as Black Monday. As per October 19th, 1987, the equity markets crashed; with declines of 5% to 11% in indices leading them to a bear market (defined as a fall of 20% or more from peak-to-trough).
The coronavirus epidemic is obviously still to blame for this new panic. In particular, the drastic containment measures taken by the Italian government, which lead to the quarantine of the entire country, raise fears that such measures may be extended to other European countries, or even the United States.
This would result in a sharp freeze on economic activity in proportions that investors were not necessarily expecting, which could drive the global economy into recession. Along with this risk, identified but increasing, was added the spectre of an oil war and especially its financial consequences.
The failure of OPEC and Russia’s discussions on the control of oil production, which led the cartel to remove all limits on its own production, drove the price of a barrel down by nearly – 30% at the opening on Monday. This collapse has fuelled many fears as it could be fatal for the fragile and indebted US energy sector (particularly shale oil) by causing a series of defaults. This, in turn, would result in significant stress on the US credit market and even a liquidity crisis.
Faced with this double fear, monetary policy announcements may not be enough in the short term. Governments are caught in the crossfire, caught between thinking about how to stem the outbreak of covid-19 and finding ways to support the economy. This blur situation is likely to last for at least a few more days.
What impact on the main asset classes?
On the equity markets, the declines are sudden on all markets, but the more cyclical sectors, in particular the energy sector, as well as banking stocks, are more clearly sanctioned. As in the first downturn, emerging market equities are holding up better than developed economies. On the credit side, while the Investment Grade is still holding up, High Yield is driven by risk aversion and liquidity tends to dry up. Government bonds deemed “safe” continue to be sought, driving rates down. The German 10-year rate thus touched a historic low at -0.9% while its American counterpart approached 0.31%, before returning to around 0.50%.
What are we doing in this context?
We believe that uncertainty should persist for at least a few more days. In this context, the meeting of the European Central Bank on Thursday will be particularly scrutinized, although it is not clear what action on its part could reassure investors. We will also have to pay close attention to the American situation. Figures for the United States’ Covid-19 epidemic are now likely to be very undervalued from reality and an update to these data would not be possible without raising new fears. Finally, of course, following the Italian precedent, there is a significant risk that containment measures will increase in Western economies. And this, even in the United States, where a freeze on activity could also put additional pressure on sectors already weakened by the oil collapse, with a potential snowball effect as a result.
Faced with this situation, hedges and defensive strategies have been taken or strengthened in allocation funds. For equity funds, while there is no doubt that this decline offers entry points to the quality issues identified by our teams, we believe that we must remain patient in the short term and take up risk only very gradually.
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