Rolling Coronavirus updates - ECB 'like a doctor who has run out of medicine'

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InvestmentEurope is providing ongoing coverage of responses from the fund industry to developments linked to the spread of Coronavirus.

05/03 1530 UMT - Central bank action not all welcome

Ian Lance, portfolio manager of the RWC Equity Income Fund, commented:

"Central banks have sought to dampen volatility, but have made the financial ecosystem much more fragile. By continuously intervening at the first sign of a market correction, they send the signal that they will always backstop the market and thus encourage businesses and investors to take excess risk.

"The build-up of these type of risks makes the financial system more fragile. It is impossible to know what event will trigger a sudden reversal in markets. All we do know, is that the more fragile the system becomes, the more likely it is that we experience some form of a re-set in asset markets.

"Periodic market declines warn investors against taking too much risk and prevent more severe crashes. Conversely, a policy aimed at eliminating volatility will lead to complacency, and there has been a belief that markets will continue to rise, creating a feedback loop which means more credit drives asset prices higher.

"During economic booms confidence is high, and is characterised by excess credit and high asset prices, but this results in poor market discipline and declining standards as confidence leads to excessive risk-taking. This is what we are seeing come to pass now."


05/03 1530 UMT - Potential optimism

Paul Eitelman, Senior Investment Strategist, Russell Investments, commented:

"We do note that one potentially encouraging sign very recently is the relative stability of high yield credit spreads, which have plateaued below 500 basis points. This is important because credit markets can be a useful watch point to gauge the amount of left tail risk that fixed income investors are pricing in on a high frequency basis.

"We think the likelihood of negative rates in the U.S occurring is low. The Fed appears happy to follow the playbook from the GFC as needed - overnight interest rates at zero, forward guidance and large-scale asset purchases. Relative to their counterparts in Europe, the Fed appears much more concerned about the costs of negative rates, including bank profitability and disruptions to the functioning of money markets.

"The 10-year Treasury yields are plumbing all-time lows, real interest rates are negative and central banks are trying to inject accommodation. Investors are risk averse and flocking to the safety of government bonds. We would expect 10-year Treasury yields to gravitate back up towards 1.5-2% over the next 12 months, provided risk aversion from the virus fades. But this is a low-conviction view, in terms of both the timing and magnitude of any normalisation. In our view, US government bonds are still considerably cheaper than their developed market peers.

"The bottom line here is that even at these very low yield levels, we still believe government bonds have an important diversifying role to play in multi-asset portfolios."


05/03 1100 UMT - Video comment on Coronavirus

Colin Moore, Global chief investment officer at Columbia Threadneedle, has commented on video:


05/03 1030 UMT - Stress test suggests global equity rout around -20%

Thomas Verbraken, executive director, Risk Management Solutions Research, Chenlu Zhou, executive director, Multi-Asset Class Factor Research Team and Juan Sampieri, senior associate, Portfolio Management Research at MSCI have commented:

"The Novel Coronavirus Covid-19 has now spread to dozens of countries — at steep human cost — and many equity markets recently recorded their worst short-term losses since 2008. But how much further could markets drop? The answer may depend on growth expectations and the degree of risk aversion adopted by market participants.

"We used a new macroeconomic model to estimate the market effects of a severe but plausible short-term downside scenario. At the end of March 3, our model-based macroeconomic analysis indicates that U.S. equities could drop a further 11%. Meanwhile, our stress-testing analysis says that a well-diversified 60/40 portfolio could lose approximately 7%: In this scenario, global equities could lose slightly more than 10% — while Treasury bonds could gain 2%, offsetting some of the equity losses."

How could a pandemic impact the macroeconomy?

"The global spread of Covid-19 is already affecting global growth. Disruptions in the global supply chain and decreased consumption affect companies' earnings in the short term. Combined supply and demand shocks could lead to a severe short-term decrease in GDP growth. It is less clear whether the coronavirus will have long-lasting effects. A sustained crisis could, for example, lead to persistent changes in global supply chains, contributing to a partial reversal of global trade and how companies conduct their businesses.

"The exhibit below compares a short-term shock only (dark blue) with a combination of short- and long-term shocks (yellow). While the short-term scenario leads to only a one-time drop in output — after which we return to a normal growth regime — the long-term scenario leads to persistently lower growth. The latter could have significant implications for future equity-market performance."

"But there is a further driver for financial markets. As uncertainty increases over future growth, investors may turn more risk-averse and demand a higher premium to compensate them for the additional risk they are taking on. If they do so, they would discount future earnings more aggressively and lower companies' valuations, affecting market prices."

Implications for markets

"How much room is there for further losses in the near term? In our scenario, we assume short-term growth drops by 2 percentage points and the equity risk premium increases by 2 percentage points in response to heightened uncertainty about long-term growth.3 Based on those assumptions, our model indicates the potential for a 22% drop in the US equity market in the near term, relative to a baseline scenario without the growth and risk-premium shocks, according to our model.

"To see the potential short-term impact on a global multi-asset-class portfolio, we created a stress test using MSCI's predictive stress-testing framework to propagate our main assumptions to all other risk factors impacting portfolio returns.4 We assume that U.S. equities could drop 22% in the near term, relative to a baseline scenario. We also assume that the 10-year Treasury yield could drop by 90 basis points (bps); U.S. investment-grade credit spreads could widen by 60 bps; and high-yield credit spreads could widen by 200 bps."

"Under this scenario, our stress test shows that a 60/40 model portfolio could lose approximately 12% and global equities could lose slightly less than 20% compared to the baseline scenario — while Treasury bonds could gain 6%, offsetting some of the equity losses. Both corporate investment-grade and high-yield bonds could suffer market-value losses as credit spreads widen, but those losses could be partially offset by the decrease in yields.5 The market has already reflected some of the changes; as of the end of trading on March 3, this hypothetical portfolio could drop 7% under our scenario.

"If the global economy suffers only short-term pain, the market could bounce back once the shockwave of uncertainty dissipates, according to our analysis. However, if long-term growth — and as a result, corporate earnings — took on a lower trajectory due to the pandemic, the market impact could be felt over a much longer horizon. By 2030, our model shows that the cumulative impact on US equity could improve to -3% (from -22%) with only a short-term shock, but could rebound to only -10% with both short- and long-term shocks, as we can see in the exhibit below."

"As the coronavirus spreads across the globe, investors are assessing the potential impact on the economy and their portfolios. As we show in our stress test, there is still room to fall for both U.S. equities and a global diversified portfolio. A longer-term shock could have more severe implications."


05/03 1005 UMT - ECB outlook 

David Zahn, head of European Fixed Income at Franklin Templeton, commented:

"It's no surprise we've seen some challenges to global economic growth arise, first with lower export growth in 2019 and this year, the Coronavirus outbreak that originated out of China. We think the virus will likely be a one-time knock to eurozone gross domestic product (GDP) growth for the first half of 2020; then, we'd expect growth to likely recover back to current levels later in the year.

"Many countries in the eurozone composite purchasing managers' indexes (PMIs), a much-watched indicator of economic activity, are in contractionary territory—Germany is the main culprit as the largest exporter out of Europe with a large exposure to the slight slowdown in Asia. However, we believe most of the contraction is likely behind us, and would expect domestic demand for the rest of 2020 and beginning of 2021 to support moderate eurozone growth of around 1%."


"It's important to remember the European Central Bank (ECB) remains incredibly accommodative in its policy decisions. At the same time, countries such as France have gone through robust reforms, ranging from business investments, changes to employment laws and corporate tax cuts. Germany and the Netherlands have room to ease budgets, but we don't expect much adjustment."