Coronavirus crisis – already over?

Investment Policy, May 2020

Coronavirus crisis – already over?

Globally, governments have underestimated the spread of the coronavirus. Which is one of the reasons why they have now promised massive amounts of financial assistance for households and businesses. The International Monetary Fund (IMF) is warning that the crisis could be more damaging to economies than the 2008/2009 financial crisis. For investors, ensuring diversification through defensive investments is vital. Defensive diversification entails overweighting equities with below-average beta/market sensitivity as well as high-quality bonds, and overweighting gold versus cyclically sensitive commodities. 

The coronavirus crisis is – first and foremost – a global health crisis. This means that when the health of a respective country faces less of a threat, the recession and negative impact on the financial markets could die down again – or could deepen in a second or third wave if the threat to health, i.e. the risk of the infection spreading, is not drastically contained. The health of a country’s population – its economic players – must be the priority. This is also because recent studies from the Fed, the US central bank, on the economic impact of the Spanish Flu in 1918-1920 have shown that – in a multi-year comparison – the federal states and districts that fared best in economic terms were those that intervened most aggressively to contain the virus (Federal Reserve of New York study: “Pandemics Depress The Economy, Public Health Interventions Do Not”, March 2020). No-one can know exactly how long the threat to health and economic downturn will last, but what we can see is that the spread of the virus and risk of infection have been underestimated thus far – which is why it could perhaps be preferable to err more on the side of caution.

The duration of the threat to health will be the decisive factor as regards the magnitude of the slowdown, and has been clearly underestimated thus far, no doubt most noticeably by the United States. Since governments are aware that they have been complacent about the threat, they have also pushed through major programmes of financial aid for households and companies. The International Monetary Fund (IMF) has warned that this crisis may well be bigger than the 2008/2009 financial crisis. Back then – as in previous major crises – the stock market correction came in several waves, and not just in one sharp shock. On a more positive note, central banks have been faster off the mark this time around. Those for whom the next few months are not crucial can hope that stock markets will move higher again in a few years, but just how long this will take is still very much anyone’s guess. The financial markets have largely priced in a slight recession, but not a severe or more protracted one. There is a clear risk that uncertainty about the virus will be around for a good while yet. This is the broad consensus at the moment. Consequently, those looking for security over return should remain cautious and continue to take a defensive stance. This is why – with regard to investments in general and equity positioning specifically – we are currently sticking with the principle of “security over return”, with defensive firms that have relatively stable business models and revenues as well as a comparatively low level of debt. 

Crises such as those in 1987 and 2008/2009 show that gold can be a defensive diversification versus equity investments.

Gérard Piasko, Chief Investment Officer

The European Central Bank (ECB) has approved a massive increase in quantitative easing, or bond purchases. This round of “QE”, which will start in April, will be unlimited, or – in the words of the ECB – “as much as necessary”. The ECB has likewise decided that, in this bond-buying programme, it will provide particular support for corporate bonds. The US central bank, too, has now again increased its bond-buying programme, to a significantly higher level than in the 2008/2009 financial crisis. Its move also serves to finance the sharp increase in government debt made necessary by the emergency assistance plan for the US population. The Fed’s bond-buying programme encompasses government bonds primarily and is practically unlimited. For the first time in the US central bank’s history, a decision was taken to buy corporate bonds rated as investment grade (but not high yield) in a bid to reduce the significantly increased financing costs of American businesses. This new and massive quantitative easing programme is also being launched by the ECB with a particular focus on corporate bonds. Consequently, we are sticking with our underweighting of riskier high yield bonds versus bonds rated investment grade and government bonds. 

Whereas many global companies are currently generating barely any income, they still have payments to make. Since, in international trade, most of these payments are made in US dollars – the US remains the largest economy – many firms are encountering a shortage of US dollar liquidity to meet these obligations. This results in other currencies being exchanged for US dollars in order to make the payments in US dollars, but the greenback remains in short supply. The Fed, acting in concertation with other central banks, has attempted to alleviate short-term liquidity by means of swap lines. The move has only been a partial success, however, which is why it can be assumed that the global demand for US dollars – from the emerging markets in particular, with their high levels of US dollar debt – is set to remain at an above-average level in the near future. It makes sense, therefore, to favour the greenback over economically dependent currencies such as those of the emerging markets and the euro.

Since oil-dependent energy commodities account for a large proportion of commodities overall, commodities remain particularly volatile. The massive downturn being witnessed currently is further impacting industrial metals, which are especially reliant on the business cycle. The oil price is experiencing virtually unparalleled volatility. Decisive for crude oil will be the outcome of the battle between Saudi Arabia and Russia for market share, though the fall in the global demand for oil due to cyclical factors will be just as significant. As a consequence, we have a clear preference for gold over other cyclical commodities. In addition, experience from the crises in 1987 and 2008 has shown that gold can be an interesting defensive diversification in a portfolio encompassing various asset classes.

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Editorial deadline: 14 April 2020

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