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Market Insights – February 24th, 2020

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

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L’essentiel

The coronavirus outbreak may already be having an impact on US economic output. Initial February forecasts for the ISM manufacturing index were below economists’ expectations, suggesting that, as the virus spreads beyond China, it could pose a threat to the nascent uptick in activity observed in recent months.

The extended lockdown in a number of Chinese cities is delaying the economic recovery. Although official macroeconomic figures won’t be published until mid-March, the latest data show that both manufacturing and consumer spending have taken a hit. However, the Chinese government has introduced a series of stimulus measures, which include a key interest rate cut, in an attempt to bolster the economy.

Germany’s ZEW Indicator of Economic Sentiment fell sharply in February, particularly in terms of economic expectations. The feared negative effects of the coronavirus outbreak are weighing heavily on sentiment. This suggests that the upturn in the eurozone may come later than expected.

The outbreak spreads

The coronavirus outbreak has entered a new phase. Contamination figures are now on the decline in China, with the number of new cases dropping over the past ten days or so and the mortality rate remaining relatively stable, at close to 2%. However, this improvement came at the cost of drastic containment measures, which will hit Chinese output hard in the first quarter and probably the second as well. But there are now virus clusters throughout the globe, with multiple cases reported in both South Korea and Italy. This means that the economic impact of the outbreak will be more widespread than previously expected, and the exact extent is still hard to gauge. In developed countries, consumer and business confidence will probably decline and some purchases and/or investments are likely to be put on hold. But the economy normally catches up once an epidemic has been brought under control. That’s surely what will happen this time too, especially since the major central banks will try to boost their economies through monetary easing. Capital markets have priced in a further rate cut by the Fed this year. But the uptick in global growth after two years of trade tensions may come later than forecast. So there could well be a downward adjustment in share prices, given their current levels. We therefore recommend reducing equity allocations slightly. This is above all a tactical decision – and no doubt a temporary move – given that the uncertainty surrounding the outbreak will probably not subside until the outbreak has reached its peak worldwide. In our investment grids, we are lowering our equity allocation by 3%, to 39%, for balanced investment profiles and by slightly more for more dynamic profiles and upping our allocation to cash and cash equivalents. The regions most affected are Asia (because it is at the centre of the outbreak), Europe (because of its dependency on China) and North America (because valuations are high on a relative basis).

Alternative funds – a look back at 2019

Alternative funds were clearly buoyed by the strong market momentum in 2019, but their returns were modest, with a gain of 8%. Unsurprisingly, the best results were posted by more directional funds, particularly equity funds that invest in growth sectors or emerging markets. Systematic funds also fared well, although they benefited more from falling interest rates than rising stock indexes. There were just a few disappointments. Distressed funds were the biggest let-down: this asset class suffered from investors’ utter lack of interest in the value segment as well as from an unexpected turn of events in several special situation funds. Market-neutral funds, which were unable to generate any alpha, also finished down.

For the fifth year in a row, more alternative funds closed down than were created. Such a tally, unthinkable ten years ago, reflects investors’ disenchantment with active management and, conversely, the sharp rise in index-based strategies. This sort of clear-out is a good thing, and the resulting decline in assets under management has so far been limited. It’s worth waiting for this trend to level off in order to make the most of the subsequent opportunities.

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