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  • The COVID-19 spread, oil price collapse and broader illiquidity in fixed income and particularly credit markets has created a perfect storm for markets and the economy.
  • As major economies essentially shut down for unknown durations to control the spread of COVID-19, pinpoint economic forecasts are unrealistic. Investors must think in terms of scenario-based outcomes as opposed to normal distributions.
  • As part of this, investors should respect the potential for aggressive monetary, liquidity, regulatory and fiscal policy responses which can trigger sharp changes in the market narrative.
  • These dynamics create extreme market volatility making market timing very difficult and prudent risk management essential. We prefer relative value to large market directional bets in the near term.
  • Longer term investors should not lose sight of the big picture. Overall economic imbalances are much healthier than prior to the Great Financial Crisis of 2008/09.
  • Expected returns for risk assets over the intermediate to longer term have increased as risk premiums have widened, reflecting near-term uncertainty.

The perfect storm

The spread of the coronavirus outside of China, oil price collapse and sharp tightening of financial conditions have put the global economy on the brink of recession. Whether or not the hit to the economy ends up meeting a formal definition of a recession, for markets it has felt like one. The 21% fall in equities over the 16 days through last Thursday rivals some of the biggest market crashes in history and the four-day widening of credit spreads from Monday through Thursday last week was even sharper than during the height of the Great Financial Crisis. All in, the S&P 500 had a max drawdown of 27% from its all-time high set on the 19th of February through Thursday, before a dramatic counter-trend surge in the final minutes of Friday's trading session erased much of Thursday's losses. Over recent months, Treasuries have held up their defensive properties (something we highlighted in our piece US Treasuries: Overvalued but Valuable) but were volatile in recent days given distress in the overall market.To state the obvious, overall cross-asset volatility is exceptionally high.

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