COVID-19 scenarios and investment ideas

Discover the latest UBS Global Risk Radar.

10 Apr 2020

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.

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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).

Central scenario

Severe restrictions to limit the spread of the virus are lifted

Severe restrictions to limit the spread of the virus are lifted by mid-May in Europe and by early June in the US, but they are partially re-imposed later in the year. A coordinated monetary and fiscal response eventually provides the necessary funding to backstop affected businesses and industries, although it arrives too late to protect all. We expect a subdued U-shaped economic recovery from the third quarter of 2020 into the first quarter of 2021. Consumer activity—measured by Google's Community Mobility Reports—should stabilize around 20% below the pre-crisis baseline by December 2020.

Downside scenario

Repeated outbreaks prove difficult to control

Repeated outbreaks prove difficult to control, leading to severe restrictions being re-imposed intermittently. A failure to keep bond markets stable and a monetary transmission mechanism that deteriorates lead to an L-shaped economic scenario. Consumer activity—measured by Google's Community Mobility Reports—does not recover sustainably (to around 20% below the pre-crisis baseline) until at least June 2021.

Upside scenario

Virus outbreaks can increasingly be controlled with technological advancements

Restrictions in Europe and the US can be gradually lifted until 3Q20, as virus outbreaks can increasingly be controlled with technological advancements and potentially better drugs. A V-shaped economic recovery takes hold. Consumer activity—measured by Google's Community Mobility Reports—moves sustainably within 20% of the pre-crisis baseline by the end of June 2020.

 

Investment implications

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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