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UBS Explains How Investors Should Position Amid Coronavirus Turmoil
Editorial Staff
26 February 2020
As the coronavirus, now called COVID-19, continues to roil global markets due to heavy disruption to the global economy - from shutdowns to fairs such as , the world’s largest wealth management house. Prefer emerging market stocks over eurozone stocks
Risk assets have come under pressure in response to signs that the COVID-19 coronavirus is spreading outside China. As with any sudden sell-off, it is important for investors to maintain a long-term perspective, and manage risks through asset class and global diversification. We prefer emerging market equities, given China's relative success in containing the virus, and are more cautious on eurozone stocks, where there is now significant uncertainty over the potential economic impact of the outbreak.
Global equities fell and safe-haven assets rallied in response to outbreaks of the COVID-19 coronavirus outside China. Reports of 215 confirmed infections in Italy contributed to a 4.2 per cent fall in the Euro Stoxx 50 index on 24 February, and South Korea's KOSPI index fell by 3.9 per cent as the number of infections there climbed to 833 (from 30 a week ago). The S&P 500 is down by 2.9 per cent at the time of writing. Gold rose by 2.2 per cent to $1,680, EURCHF fell below €1.06, and 10-year US government bond yields fell by 8 basis points to 1.39 per cent, as investors sought safe-haven assets. Meanwhile, the euro has risen marginally against the US dollar; we believe that this is likely a result of investor de-risking leading to the unwind of short euro carry trades and an increased possibility of US rate cuts in response to the market turmoil.
We prefer emerging market equities, given China's relative success in containing the outbreak there, and are more cautious on eurozone stocks, where there is now significant uncertainty over the potential economic impact.
The emergence of a large number of new cases in Italy has materially increased the risk of a sharp drop in consumer and business confidence in Europe, and potentially North America too if more cases are confirmed there in the coming days. Given the incubation period of the virus, the next two weeks will be critical in determining the extent of the outbreak, the steps authorities are willing and able to take to contain it, and the economic effect of those measures. If Europe and/or North American nations were to replicate the aggressive containment measures employed in China, it could mean materially lower economic growth in the first half of the year, and require offsetting actions from monetary and fiscal authorities to prevent a prolonged downturn. That said, we note that visibility remains low, and examples like Singapore (which has 89 cases and no fatalities) demonstrate that the virus can be controlled relatively quickly with decisive action.
In spite of increased uncertainty in Europe, signs remain good that China is succeeding in containing the outbreak there. The number of new cases in China ex-Hubei are now at very low levels, which should allow economic activity to normalise and supply chain disruption to begin to resolve itself, in line with our base case. We will continue to monitor "live" activity indicators on the Chinese economy, including coal consumption, property transactions, and volumes of stranded migrant workers returning from the Lunar New Year holiday, to confirm this trend.
As with any sudden sell-off, it is important for investors to maintain a long-term perspective, and to manage risks through asset class and global diversification. It is also important not to neglect other factors which can drive the market, particularly given that monetary, fiscal, and other policy responses to the crisis could emerge in the coming days and weeks.
That said, there are a number of strategies which we think can help investors improve the risk-reward profile of portfolios during this period of uncertainty:
We continue to overweight EM equities, and have seen recent dips in MSCI Asia ex-Japan as providing an attractive longer-term entry point. This positioning is predicated on our view that China succeeds in containing the outbreak there in the coming weeks, allowing supply chain disruptions to resolve, consumer confidence to revive, and the economic and market impact from COVID-19 to be confined to the first quarter of the year. Assuming this is the case, we expect earnings growth of near 12 per cent in Asia ex-Japan this year. We also view valuations in Asia ex-Japan as reasonable at 1.6 times book value, a near 35 per cent discount to global peers. Meanwhile, the forward P/E discount of EM equities to developed market equities increased recently to 28 per cent, above 5- and 10-year averages.
In contrast, we continue to underweight eurozone equities. The market trades on a 12-month forward price-earnings ratio of 14.8 times, at the upper end of the 15-year range, at a time when we expect earnings to contract by 1 per cent in 2020. Now, the added economic threat posed by the coronavirus and containment measures presents another potential downside risk.
Seek "stay-at-home" and dividend stocks, and avoid sectors exposed to travel.
Taking the investment framework we employed in Asia and applying it to Europe would suggest that, within the region, a) investors should avoid the most vulnerable sectors - including airlines and hotels b) invest in "stay at home" stocks - in sectors like e-commerce, gaming, and food delivery - which we would expect to see increased demand in case of quarantine measures, and, c) seek sustainable dividend stocks - which could be seen as relative safe havens, particularly given the sharp fall in bond yields.
Benefit from higher volatility.
Volatility has jumped in response to the latest virus fears, with the VIX US volatility index rising to its highest level since summer 2019, and the V2X European volatility index at its highest since late 2018. This move in volatility increases the yield available from put-selling strategies, which can enable investors to take advantage of higher volatility while offering a more defensive exposure to equities. Investors looking for further downside cushioning can also look to structured solutions which can enhance their yield while offering a degree of capital protection.