Weekly View - Highs to lows
The final week of February rebelled in a dramatic way. In the space of six trading days, the S&P 500 fell from a historical high to a cumulated decline of over 13% by month’s end as markets grew suddenly aware of the latest coronavirus’s potential to become a pandemic and disrupt global activity. This was the fastest correction in the history of the index, the de-rating of which brought its price-earnings ratio from a lofty 19x to close to 16.5x. Beyond the US, global equities suffered their worst week since the Global Financial Crisis. We have for now reduced our equity exposure from neutral to underweight until we can be more certain that a global recession will be avoided. Equity-market volatility, as measured by the VIX index, jumped its highest level since 2011. We continue to play volatility as an asset class – using it while it is high to buy in areas of the market we like at lower prices.
The price action in the fixed-income space was equally dramatic to the 10-year yield on US treasuries, which fell to an all-time low of 1.15% as the market prices in almost four Fed rate cuts this year. Financial stress spread to credit with the high-yield energy sector particularly exposed. As long EM and carry trades were unwound, the currencies used to fund these positions bounced back as a result, including the EUR and the JPY, which last week were both up between 2-3% in trade-weighted terms. We like defensive currencies like the JPY in the current environment.
Looking ahead, it remains anyone’s guess if and when the virus’s spread beyond China will stop, but markets appear positioned for a very grim scenario for earnings and economic growth extending to Q2, if not beyond. Chinese PMIs declined to a larger degree than expected in February, as manufacturing sentiment was hit particularly hard. Investor focus will now turn to other countries, as well as a number of key indicators to be released this week in the US and upcoming central bank meetings later in the month. The current situation calls for concerted monetary and fiscal support, with the Fed, BoJ and Italy already having signalled they will step in to provide this. While equities have started to price in a mild recession, credit markets have done so to a lesser degree, which is why we moved to underweight in European high yield.