UBS: “Coronavirus drives fastest bear market ever”

The Federal Reserve on Sunday cut rates by 100bps to 0-0.25% in a second out-of-cycle measure this month, citing risks to the economy. It also announced a USD 700bn quantitative easing program, buying at least USD 500bn worth of US Treasuries and USD 200bn of agency mortgage-backed securities, “to support the smooth functioning” of those markets.

This follows US President Donald Trump’s Friday declaration of a national emergency, which has unlocked USD 50 billion of funding to combat the coronavirus and its effects, with the House of Representatives passing measures which will mean free coronavirus testing for everyone who needs a test, two weeks of paid sick leave, and up to three months of paid family and medical leave.

The Fed and Trump’s announcements were part of a broader escalation of the global response to the COVID-19 pandemic, involving both fiscal and monetary policy measures. Germany on Friday unveiled a EUR 550 billion package to ensure the survival of vulnerable companies, with the economy minister pledging unlimited support “to the smallest businesses, from taxi-drivers, to the creative industries, to really big firms with tens of thousands of workers.”

The escalating response from governments comes as the spread of the virus continues, with almost 170,000 reported cases and around 6,500 fatalities worldwide, along with mounting evidence of economic disruption. Countries across Europe moved to seal off borders, with Spain, France, and the Netherlands imposing restrictions on movement in their own countries. Meanwhile, Apple said it would close all stores outside Greater China.

Market volatility looks set to continue this week. S&P 500 futures hit the down limit in early Monday trade. Asia-Pacific assets sold off Monday, led by a 9.7% plunge in Australian stocks. The Euro Stoxx 50 was around 7.5% lower at the open. The US dollar declined 1.4% against the safe-haven yen, while notching gains against commodity-linked currencies like the Canadian and Australian dollars. US Treasury 10-year yields fell 30bps to near 0.65%.

Volatile trade last week, with a sharp rally into the Friday close following the 9.5% plunge on Thursday, demonstrates that the market is willing to reward targeted policy action designed at mitigating the virus’s spread and limit its economic impact, even if broad-brush measures like interest rate cuts have been poorly received.

It also demonstrates the importance for investors of not making rash decisions during periods of elevated market volatility. Many of the markets’ best days in recent history have come in months which have also brought the worst days. Panic selling after steep declines can therefore mean enduring the worst days while missing the best.

What are we watching?

Friday’s rally capped a historic week in financial markets, which saw the fastest bear market in US history, a record one-day fall in European stocks, a near-record collapse in oil prices, and spells of illiquidity in government bond markets sparking panic and indiscriminate selling, with the VIX hitting 75, just 5 points short of its 2008 record.

In the weeks ahead, we think markets will be focused on the following factors:

• Evidence of virus containment in developed markets. Efforts taken to contain the virus outbreak in China and South Korea have proved successful, and the weekend brought encouraging news that no new infections have been reported for 48 hours in the Italian town of Vo’ Euganeo, one of the first places in Europe to be locked down. As the pandemic spreads in Europe and the US, Italy has led the way in taking strong measures to counter the outbreak, imposing nationwide travel restrictions and closing most of the country’s shops. If these actions prove to be successful, it could provide investors with some confidence that the virus can be contained in a European country, but also raise fears about the potential economic cost of getting there.
• Evidence of measures to mitigate the economic impact of the virus. The markets’ warm reception to President Trump’s declaration of a state of emergency, and to German Economy Minister Altmaier’s earlier announcement giving the green light for KfW, the German state bank, to lend as much as EUR 550 billion (USD 610 billion) to companies to ensure they survive the pandemic, shows that the market is looking for confidence that the crisis will not provoke widespread bankruptcies among SMEs and corporations. Measures like mortgage repayment holidays or credit amnesties for affected workers and small businesses will help reduce the depth of recession and speed the recovery. In contrast, economically costly measures, which do relatively little to contain the virus, like travel bans, are likely to be taken negatively by the market, as seen last week and as futures are pointing to today.
• Evidence of further broad policy response. Broad fiscal spending and rate cuts are blunt instruments for dealing with the short-term economic impact of the virus, but should provide investors with some confidence that growth can be strong once the recovery gets underway. Meanwhile, central banks will need to continue to be on the alert for illiquidity, after signs of stress in the Treasury markets last week. The market’s rally on Friday was also supported by US Treasury Secretary Mnuchin repeating Alan Greenspan’s famous pledge that: “There will be liquidity available. Whatever we need to do, whatever the Fed needs to do, whatever Congress needs to do.” In a global coordinated move by central banks, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank are moving alongside the Fed to boost dollar liquidity.

What do we recommend?

We expect the market to end the year at much higher levels than today, with China’s economy leading the way to recovery and the US and European economies rebounding in the third quarter. But investing while volatility remains so high is clearly challenging. In this environment, we recommend the following strategies:

• Combine an averaging-in strategy with put writing. Averaging-in enables investors to deploy capital while smoothing near-term bumps, while, for investors who can implement options, put-writing strategies provide a yield and a pre-commitment to investing during dip-buying opportunities. Read more.
• Favor strategies that improve portfolio yield, including buying dividend stocks and US high yield (HY) credit, amid near-record low yields and falling rates. While there is scope for further near-term spread widening in HY, over a six-month time horizon we expect spreads to be considerably tighter. Read more.
• Prepare for US dollar weakness. After the Fed’s move, the long-held US yield advantage is shrinking. Our forecast is for further dollar weakness over the course of the year, and project EURUSD at 1.19 by December 2020. Read more.
• Risk-averse investors may consider measures to protect portfolios against coronavirus risks, including adding exposure to gold and longer-duration US Treasuries. Read more.
• Use the drop in markets to buy into long-term themes. Although the sell-off has affected all sectors, the crisis may also accelerate longer-term trends in connectivity and localization, benefiting companies exposed to the fourth industrial revolution and digital transformation. And, even after the current crisis passes, an aging global population, developments in healthtech, and recent strides in genetic therapies all offer long-term opportunities for investors seeking long-term portfolio growth. Read more