Coronavirus and other market risks for 2020

Discover the latest UBS Global Risk Radar.

06 Feb 2020

The coronavirus has introduced new uncertainty to a market that has been spoiled by positive economic momentum, accommodative central banks, and the forging of a trade truce between the US and China. Since concerns over the spread of the Novel Coronavirus (2019-nCov) emerged, equities in Asia have declined around 6% and oil prices 14%, while safe-haven assets such as gold and US Treasuries made gains.

The relatively strong market response to the virus illustrates how markets tend to react to negative news when valuations for most risky assets appear high and investor positioning in some areas looks stretched. As we have seen, any negative surprise can lead to larger drawdowns than during earlier stages of the cycle when valuations are usually lower.

On a more optimistic note, market participants now seem to have a better understanding of the key market risks that CIO is monitoring. Furthermore, our assessment is that these risks have a rather low probability of materializing over our tactical investment horizon of around six months. That being said, in light of the heightened market vulnerability, these risk topics deserve special attention. In this report, we cover scenarios around the global business cycle, the US elections, the global trade dispute, and the Middle East crisis.

Risk map: business cycle risk and trade related news from US, Eurozone and China could impact global markets


At a glance

In the latest edition, key investor takeaways include:

  • The coronavirus has added uncertainty to an otherwise low-volatility market environment. Recent developments suggest that the spread of the virus can be contained.
  • Overall economic momentum remains positive and monetary conditions are loose. However, monitoring key risks is warranted as markets tend to be more vulnerable to setbacks at an advanced stage of the cycle. Global trade talks, the US election, the global business cycle, and potential geopolitical flare-ups such as conflict in the Middle East will be important risks to watch in 2020.
  • We are overweight equities with a preference for emerging markets, which look poised to outperform their developed market peers.

 

Why the coronavirus matters for markets

Global financial markets have reacted strongly to rising concerns over the spread of the Novel Coronavirus. As of this writing, the virus has killed 565 people and infected around 28,000, according to data from the World Health Organization. We are closely monitoring the situation and will continue to communicate our views via different channels.

One interesting question clients have asked is why the financial markets are paying much more attention to the coronavirus than they have to seasonal flu, which infects and kills far more people each year. We think this is because the unknown nature of the coronavirus primarily impacts markets as it creates the fear of an uncontrollable global pandemic. Fear itself can cause governments, businesses, and households to take severe preemptive measures, causing significant collateral damage to the economy. For example, the temporary closure of factories in China poses a risk to global supply chains, especially as this comes on the heels of a similar threat posed by the latest global trade conflict.

Market impact

All told, the impact on economies and markets is hard to assess, and we can only go by the assumptions we can make by looking at similar events in the past. The SARS coronavirus outbreak of 2003 comes closest to the current situation. For China, we expect a deep hit to first-quarter economic growth, which made us revise down our full-year growth forecast from 6% to 5.4%. This reduces our global GDP growth forecast for 2020 from 3.1% to 2.9%, but it should rebound into 2021 to 3.7%.

Short term recommendations

  • Avoid vulnerable companies in Asia
  • Invest in "stay at home" stocks
  • Buy high dividends
  • Take advantage of higher volatility via put-writing strategies and structured solutions

Long term recommendations

  • Stay diversified in an asset allocation context
  • Refer to Longer-Term Investments themes

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Will the global business cycle end in 2020?

Economic cycles ("business cycles") – from recovery, to expansion, to overheating, to recession – may be the single most important driver of financial market returns over a six- to 12-month investment horizon.

Over the past few decades, the integration of supply chains and financial systems has made business cycles a largely global phenomenon. Global recessions are usually preceded by equity bear markets, with global stocks losing at least 20% of their market value over a period of six months or more. Today, the global business cycle is largely driven by two of the world's largest economies: the US and China. Monitoring these economies for signs of a cyclical downturn is key in deciding the appropriate level of risk in an investor's portfolio.

Current state of the business cycle

Forces that drive economic cycles in any given country include job creation, debt and inventory build-ups, monetary and fiscal policies, and the occasional exogenous shocks. The same applies to both the US and China, but the differences in the two countries' economic models make their business cycle dynamics fundamentally different.

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Will import tariffs undermine global growth?

On 15 January, the US and China signed a Phase 1 trade deal after months of dispute. The US confirmed a partial removal of tariffs on Chinese imports, while China promised to ramp up purchases of US goods and services by an additional USD 200bn over the next two years—greater even than the USD 186bn value of goods and services China imported from the US in 2017. The deal also establishes a new enforcement mechanism with monitoring and dispute-resolution functions. It marks an important turn for financial markets, as it reduced the risk of tariff escalation between the world's two largest economies.

By contrast, no progress has been made on US trade with the European Union, which could be the next target of President Donald Trump's administration. The US and France recently agreed on a truce in their
trade dispute, but France is joined by other European countries in planning to introduce a digital tax chiefly targeting revenues of US technology companies.

Our view: A year of temporary relief, with occasional hiccups

The US presidential elections in November should provide some relief from trade tensions as political priorities shift away from escalating mdisputes. Hence, the US administration will likely hold fire in its trade dealings with China and the EU in 2020. Global trade risks still need to be monitored, however, as many fundamental reasons for the conflicts remain in place.

The road to 2020

Discover the latest investment implications of the 2020 US presidential and congressional elections.


 

Will the US presidential campaign lead to higher market volatility?

Aside from the prolonged delay in the release of results from the Iowa caucuses, this year's primary season is unusual in three respects. First, the sheer number of candidates still vying for the Democratic nomination has resulted in a fragmentation of support among numerous candidates.

Second, the rupture between the moderate and progressive wings of the Democratic Party appears to have widened. Democratic Party primary voters, or convention delegates, will have to decide whether to nominate a centrist capable of appealing to disaffected Republicans and independents or a progressive candidate who can energize an activist base enough to increase voter turnout substantially.

Third, the decision by former New York City Mayor Michael Bloomberg to enter the race changed the calculus in the important primaries scheduled for next month. While his nomination remains improbable, his presence in the race may be enough to prevent any one candidate from garnering enough delegates to lock up the nomination before the convention.

Recent developments

The first major test of the candidates' popularity occurred on 3 February in Iowa. The state has a mediocre record of choosing national party nominees, but its position as the first official contest prompts extraordinary media coverage. Candidates that exceed expectations in Iowa often gain some momentum in subsequent contests, while those that fail to do so can encounter subsequent fund-raising challenges.

Policy issues

The contenders have promulgated a wide array of policy proposals but they do share some common characteristics. The details vary, but each one supports higher tax rates, more stringent regulatory requirements, and greater involvement by the federal government in the provision of healthcare. We believe the policy choices most likely to affect market behavior fall into four very broad categories: monetary, fiscal, trade, and regulatory policy.

Investment conclusions

We believe investors should consider strategies to increase the resilience and upside of their portfolios regardless of the electoral outcome. This can be achieved through diversification, strategies to protect against the downside, along with a focus on higher growth businesses.

Coronavirus and other market risks for 2020

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