The violence of the oil shock has added a new urgency to the broad-based de-risking that is sweeping across global markets. In just over two weeks, investor sentiment has swung from complacency to panic. What started as a virus-driven de-risking has now mutated into a broad-based, multi-asset capitulation.
Whereas last week, investors were largely focused on trying to evaluate the potential impact of the coronavirus on global growth, they are now worried about scenarios involving self-reinforcing adverse market dynamics. The oil shock has jolted the hitherto resilient markets for high-yield debt and emerging market bonds. The risk now is that investor redemptions will accelerate at a time when market liquidity is already under pressure. Still, the scale of the repricing has been so rapid today that value is already beginning to emerge. Credit markets have gone from being overbought to oversold, overnight.
The ferocity of the sell-off in risk assets reflects a massive rethink on global growth. In just over two weeks, investor expectations have shifted from broad-based complacency to pricing in a high probability of recession. Based on historic patterns, it could be argued that global equities are now pricing in a 60-70 per cent chance of a world recession.
It is far from obvious what will stabilise market sentiment. Whereas central bank actions have been effective circuit breakers in many past market sell-offs, we see limited scope for game-changing monetary policy interventions today. We expect central banks’ actions to focus on liquidity provision and keeping credit flowing through the financial system rather than trying to deliver big rate cuts or new quantitative easing programmes. Fiscal policy is clearly the right solution for the world economy’s current ails, but progress here so far has been piecemeal.
In the absence of mood-altering policy interventions, markets will remain highly sensitive to the evolving progress of the coronavirus. Concern has now shifted to the US, where the number of confirmed cases looks set to surge in the weeks ahead. Against that backdrop, investors seem unwilling to recognise that trends are now looking more favourable in China and even the South Korean outbreak seems to be coming under control.
The coronavirus presents investors with an unprecedented global problem. Investors are uncertain about the nature of the virus, its potential economic impact and the policy response. The oil shock has only added to this confusion and uncertainty. One thing we do know however is that markets are now in panic mode. While it would be foolish to try to call the bottom in the markets, we would rather be buying in this environment rather than selling. We are gradually rebuilding risk exposures into market weakness.
Paul O’Connor, head of the multi-asset team at Janus Henderson Investors
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