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Market Insights – March 4th, 2020

Each week, a team of experts shares its market views with you.

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L’essentiel

As the coronavirus sowed panic in the financial markets last week, the Swiss franc stayed remarkably stable against the euro. We strongly suspect that the SNB took steps to prevent the franc from gaining too much ground, which would weigh heavily on the domestic economy.

The Swiss economy continued to expand gradually in February. The KOF indicator came in ahead of expectations at the end of last week, buoyed by relatively optimistic economic sentiment among those surveyed. This bright outlook was confirmed by the manufacturing indicator, which was at a nearly one-year high when it was published today.

The pound has come under pressure since Boris Johnson and his government adopted a hard-line approach to post-Brexit trade talks with the EU. And the fears plaguing the financial markets have put more pressure on the pound, which is likely to remain volatile for the next few months.

The markets probably overreacted

Investors have realised that the coronavirus will have a negative impact on the economy. Judging by last week’s rout, it’s been a rough wake-up call, with some indexes shedding more than 10% overall. The economic impact of the global epidemic was one of the reasons that led us to reduce our portfolios’ equity exposure early last week. While the economic fallout is hard to gauge at this point and will depend in part on how long the outbreak lasts, the current panic seems overblown when you look at the low mortality rate of coronavirus relative to past epidemics. There are around 90,000 confirmed cases of infection around the world, and more than half of those patients have fully recovered.

The epidemic is being brought under control in China, where the health authorities have been able to contain the virus by acting quickly. Other governments around the globe are trying to do the same. Once they’ve put in place the necessary health measures, the authorities will have to quickly come up with economic ones. In the coming weeks, we can expect monetary and fiscal stimulus measures to be announced, first by the central banks, which will inject liquidity into the markets and cut interest rates. The US Fed is all but certain to lower its benchmark rates at its next meeting, on 18 March. Even though last week’s correction didn’t surprise us, we believe it was excessive. Given the extent of capitulation selling, the markets may now be oversold in the short term and close to bottoming out. 

That’s the signal we’re getting from volatility indicators like the US VIX, which is at its highest level since February 2018, not to mention most other sentiment indicators that quickly started churning out extremely pessimistic readings. What’s more, valuations have dropped back to much more moderate levels by historical standards (with a market-wide P/E ratio of 16.5x in the US and 12–13x in Europe and emerging markets). Once the global outbreak peaks, investors are likely to turn back to the stock markets. In our view, it is too late to sell. We need to start looking at individual stocks and long-term themes that bore the brunt of the panic selling in recent days and that may now be worth buying.

China – back to work

It took only a few days for the markets to go from complacently viewing the epidemic as a temporary event to reaching a state of panic. The outbreak is still spreading quickly across Europe, but China appears to have discreetly turned the corner in its battle against the virus. The latest numbers show that the number of patients who have recovered from the disease is now higher than the number of currently infected patients.

The full extent of the outbreak was obscured until now by the draconian isolation measures put in place right after the Chinese New Year holiday. Economic activity has picked up more slowly than expected, as we see in the purchasing managers’ indexes published this past weekend. The manufacturing PMI dropped from 50 in January to 35.7 in February, the sharpest contraction ever recorded. That’s not surprising, however, since the economy came to a standstill for most of February, although it should start to pick back up in March. High frequency economic indicators have been flashing green for the past week, including the number of visits to shopping centres and the manufacturing capacity utilisation rate, which is now back above 50%. 

When it comes to predicting how other infected regions will fare, the pattern by which the infection rate is stabilising in China could be a better guide than the SARS virus, although the effectiveness of the containment measures and the population density are not fully comparable. The speed at which the virus is spreading in South Korea and Italy is certainly worrying, but last week’s correction made clear that the outbreak is truly being taken seriously. At this point, the greatest threat is fear. We just need to keep in mind that, once the panic recedes, the markets will quickly move on.

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