The brutal decline on Monday, February 24, was only the first episode of a week of violent correction, which saw equity markets experience their worst week since 2008. The S&P 500 lost -11.4% and the Euro Stoxx 50 -12.3%. The bonds of countries deemed “safe” were highly sought after, causing the German 10-year rate to fall below the level of -0.60%.
Why this panic?
The acceleration in the spread of Covid-19 outside China, and particularly in Italy, has reaffirmed the risk of a pandemic that investors have previously discounted. Beyond the emotional responses to the virus itself, the main fear was that closures and quarantines would increase in developed economies, against which the measures of central banks and governments could be of limited effectiveness. In addition, the lack of a coordinated initial response from the authorities (reflected in the lukewarm speeches of European Central Bank officials midweek) left the markets in doubt.
What impact on the main asset classes?
Within the equity markets of developed countries, the decline was widespread and little discriminated against, both geographically and in terms of sectors. Thus, the growth stocks on which the bubble risk was beginning to weigh did not fall more than the rest. Nevertheless, we should note that emerging markets equities, particularly in Asia, held up better. This is due to the fact that new cases of Covid-19 are increasing in the rest of the world while they are steadily declining in China, and also to the early action of the central bank of China. On the bond side, the yields of countries deemed “safe” fell sharply, while those of peripheral countries, such as Italy or Greece, tended to rise, while they had followed the same trajectory as core countries. The credit market, for its part, has been very resilient, although the lowest-rated segments have not escaped risk aversion.
How did the authorities react?
The Fed caused a sensation by surprisingly lowering its key rate by 50 basis points on Tuesday 3 March, outside its ordinary agenda. Australia lowered its rate by 25 basis points. The Chinese authorities have announced monetary, fiscal and budgetary support measures for the economy. The ECB issued a statement saying that it was monitoring the situation very closely: we can expect future actions. Thanks to these very accommodating policies, States have significant resources at their disposal to implement recovery plans.
What to expect in the coming weeks and how to act?
At this stage, three scenarios seem to emerge. The darkest scenario, but also the least likely, would be an acceleration of such contamination that it will result in the implementation of drastic measures, such as massive closures of companies, a freeze on transport, even full or partial border shutdowns. Such a scenario would undoubtedly entail a major market shock and, even if, ultimately, there is no doubt that central banks and governments would act, the damage to risky assets would initially be violent.
At the other end of the spectrum, we can imagine an optimistic scenario in which the spread of the virus would slow down sharply in the coming weeks. The risk of a pandemic would, in this case, be avoided and only the properly calibrated economic support measures to make up the air gap in the first quarter.
Our scenario is more median. Hoping on a rapid slowdown in the epidemic does not seem reasonable to us, since many unknowns still remain around the virus and its possible evolution. However, we believe that, with the wind of panic, more pragmatic views should regain control. The Covid-19 will be a pebble in the shoe, with which the economy must learn to walk, without stopping. Adequate measures will be implemented gradually to limit spread, particularly among the most vulnerable populations. Central banks, supranational institutions and governments, which have just begun to announce measures, will intervene to bolster activity. It should also be kept in mind that remedies are under study.
In the short term, we should remain patient because volatility will continue to prevail. Nevertheless, we are convinced that the exit from this stressful episode will be from the top and that gradual purchases may prove to be relevant. Central banks and governments will not let financial conditions deteriorate unduly.
These comments correspond to the management’s convictions at the time of writing.
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