At a glance
First identified as a low-probability risk in our report from early February, the COVID-19 pandemic has since clearly become the single most important driver for financial markets over the last months. After posting some of the sharpest losses on record in March, equity markets have shown signs of a recovery recently, but remain well below their peak levels from earlier this year. In this edition, we map three possible scenarios and explain related investment implications for the months ahead.
Looking ahead, with caution
The length of the current economic shutdown is perhaps the most important starting point for all projections of economic activity, including corporate earnings and defaults. It will largely be determined by how quickly the spread of the virus can be contained, but there are also additional factors impacting the length of the shutdown itself (e.g. virus developments, availability of suitable medication, risk of a second virus wave), as well as the degree of economic damage (e.g. degree of fiscal and monetary support).
Market participants grapple with the same set of uncertainties as does the general public. The longer it takes for countries to contain the outbreak and resume economic activity, the longer-lasting and more severe the economic damage from corporate defaults, rising unemployment, and foregone transactions. The more economic damage investors expect, the more pain is endured by financial markets.
With that in mind, we think credit markets are closer to pricing in our negative scenario while equities seem closer to our base case. We believe this presents a good buying opportunity in credit-related asset classes, especially in US investment grade and high yield corporate bonds, as well as emerging market sovereign bonds issued in US dollars. We see limited downside in these asset classes even in the case of a longer-than-expected shutdown, but equity-like returns in our central and upside scenarios.
In the full version of the report, we provide more detailed ideas about how investors can position for each of our virus scenarios.
COVID-19 scenarios and investment ideas
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