UBS House View – CIO Alert
Rally resumes on hopes for relaxation of restrictions
The S&P 500 rallied 3.4% on 8 April, lifting it 23% above its recent low on 23 March and just 18.6% from its 19 February all-time high. Sentiment remains volatile, but investors appear to be looking through the growing headline numbers of COVID-19 cases and focusing on signs that the spread of the pandemic is being brought under control, which in turn is underpinning hopes for a relatively swift relaxation of containment measures.
There were a number of positive developments on Wednesday:
- Anthony Fauci, director of the US National Institute of Allergy and Infectious Diseases, said the turnaround in the battle against the coronavirus could start after this week. President Donald Trump also tweeted that the country would be reopened "sooner rather than later."
- In China, the lockdown of Wuhan, the city where the coronavirus was first detected, ended after 76 days. Flights, highways, and railways have all been reopened for residents who are deemed COVID-19-free, although authorities are discouraging unnecessary travel.
- In Italy, the number of new confirmed cases increased to 3,836, but this reflected a significant jump in the number of daily tests carried out, and the ratio of positive daily test results fell further to 7.4%, down from 9% on Tuesday and 17% last Thursday.
- Markets also drew support from the announcement that Sen. Bernie Sanders was withdrawing from the race for the Democratic nomination for president. While former Vice President Joe Biden had already accumulated a nearly insurmountable delegate lead, there was some concern that Sanders’s candidacy still represented a potentially disruptive presence for markets, by giving him an avenue to push for some of the more extreme policy proposals from the progressive wing of the party heading into the convention. His departure reduces this risk and therefore increases the prospects for a more market-friendly centrist platform emerging from the party convention.
In conjunction with yesterday’s news that Austria and Denmark plan to ease restrictions after Easter and a growing consensus that a combination of testing, tracking, and face masks could be an “exit strategy,” these latest developments have increased optimism that parts of Europe, and the US shortly after, could follow China’s experience of a relatively swift return to “normal” economic activity. That said, we believe it is too early to call a turn in the pandemic and the situation remains fluid. The UK announced on Wednesday its highest daily death count since the virus broke out. The US will also have to endure a very difficult week, according to the Trump administration.
Broadly, we think the market is currently pricing in that economic activity will start to normalize from early-to-mid-May, but that the recovery will be gradual, with economic activity and earnings in 2021 still shy of levels achieved in 2019. In a highly uncertain environment, we think further upside for the broader equity markets would be better supported once we have more evidence that stimulus measures are working, additional monetary or fiscal stimulus is added, we get greater clarity about the “exit strategies” governments are beginning to develop, or a medical breakthrough takes place. Downside risks include a spike in new cases, announcements of extended lockdowns after Easter, or signs that monetary and fiscal stimulus are not sufficiently mitigating business closures or an increase in joblessness.
At this point, we prefer more selectivity in equities and see a better reward-to-risk relationship in credit, which in our view is pricing in a higher chance of our downside targets materializing rather than our upside. In particular, we see opportunity in US high yield, US investment grade, USD emerging market sovereign debt, and green bonds. Read more here.
Again, that doesn’t mean there are no opportunities left in stocks. For those looking for further upside, we advocate seeking 1) oversold stocks across the US, Europe, and Switzerland; 2) resilient stocks (such as select consumer staple and healthcare names, as well as global quality stocks); and 3) longer-term winners such as those in genetic therapy, digital transformation, oncology, and food.
Investors who are worried about renewed market declines have several options. They can increase their strategic allocation to high-quality bonds, in particular longer-duration Treasuries, or add capital to a dynamic asset allocation strategy. In addition, investors can also consider gold, as well as capital protection strategies that, if markets still go up, participate in the upside, but also lock in recent gains. We also see opportunities in stocks in Asia that are relatively cheap and likely to experience limited earnings impact from the virus, as well as stable and quality stocks globally that should be resilient during times of market distress. Read more about protecting against the downside here.
The recent rise in stocks might also leave some investors waiting for a renewed decline before investing, given the uncertainties from the crisis. But this approach runs the risk of sitting on the sidelines for a prolonged period before potentially buying in at a higher level. One way to build up long-term positions in the market is to combine an averaging-in strategy with put writing. Averaging into riskier assets enables investors to deploy capital while smoothing near-term bumps, while for investors who can implement options, put-writing strategies can provide an additional yield, while pre-committing to investing if markets drop further. More on this here.