Coronavirus, Market news | 17 March, 2020

Coronavirus: Economic situation analysis

Alberto Villasán Investment and Markets Director

What is happening in the financial markets?

Over the past few weeks, we have witnessed sharp declines in all global equity markets accompanied by other strong movements in most financial assets.

European stock markets have experienced around 30% in just two weeks, while in other countries, such as Brazil, falls reached 50% compared to the levels at the end of last year.
The reason behind these sharp declines is the spread of the COVID-19 virus, commonly called the Coronavirus, and its foreseeable effects on the global economy, corporate profits, and productive fabric.

The dimensions and speed of the falls are incredibly forceful in historical terms, only comparable to 1929 and 1987 when the markets fell sharply, giving rise to further declines in the case of 1929, and a full recovery in the case of 1987.

Over the past week, corrective movements have taken place in both equity markets and other traditionally less volatile markets, such as the credit market (corporate and government bonds), highlighting the uncertainty of global investors about the magnitude and consequences of the spread of the virus.

What could be the consequences for the economy and the markets?

At this stage, it is challenging to predict the consequences of the real economy and the business sector. The reason is that there are no historical situations with which to compare the current context reliably. We believe, in any case, that the global economy is weakened due to the high level of debt, so we are cautious about how the economic activity will be affected.

Investors must bear in mind that the economy is not something that can be turned on and off in a “binary” manner and that the situation of many companies and productive sectors was already very fragile before the crisis. As an example, a third of the 2000 companies in the Russell 2000 Index for US small-cap companies had negative earnings at the end of 2019, a situation typical of periods of crisis and economic recession.

It is reasonable to think that many of these companies could have serious solvency problems if they do not receive income for a “long” period.

As for the financial markets, most of them present less “expensive” valuations after the falls in their prices. Investors should bear in mind that less “expensive” costs are not synonymous with “cheaper” valuations and that, therefore, it is not ruled out that we may face further falls in the markets if the situation worsens and the global economic recession materializes.

On the other hand, we are confident that governments and central banks will do everything possible to maintain economic activity and “subsidize” weaker sectors and companies through packages of monetary and fiscal aid, so the real damage could be less than that current circumstances indicate.

The main problem is that it is exceptionally complex to predict the impact and depth of the crisis given that we have no history and the situation is entirely new, not only for investors but also for governments and other economic agents.

What do we recommend doing in these circumstances?

As many of our readers will already know, the process of building an investment portfolio comprises two critical decisions: A strategic choice, with an investment horizon of 3 years, and a tactical decision, with a background of 1 to 6 months.

  • The strategic decision refers to the level of structural risk of your assets. For this, we usually take into account the valuations of long-term assets and their expected returns.
  • The tactical decision takes into account the vision of the short-term markets. It is usually the minority part of a portfolio’s risk, given its level of unpredictability and degree of volatility in prices during that period.

In this environment, in which financial assets are less “expensive”, we do not recommend modifying the level of long-term risk (strategic positioning) until the development and depth of the crisis become clear. We consider that the assets have not adjusted their valuations enough to substantially increase the risk without insights into how the situation will evolve.

Regarding tactical or short-term decisions, the current high-volatility situation is the perfect environment to modify and leverage it based on the levels of oversold markets, dynamics or momentum of the rest of investors, and market consensus. However, it should be noted that we always advise that you represent a minority part of the portfolio.

Other considerations

There are also other equally relevant considerations when investing in this environment, such as how you can protect your assets, the liquidity of the financial markets, or investment assets and ideas to avoid.

Their relevance and degree of complexity have led us to create a series of technical notes, which will be releasing over the next few days, while we will make a detailed update on the progress of the crisis and the financial markets.

Finally, we would like to emphasize the positive performance of our investment strategies in this environment, differing significantly from other investment strategies on the market, as well as from the leading financial indexes. Protecting the assets of our clients and having all the purchase potential to take advantage of the opportunities that the financial markets should be offering us in the coming quarters.