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30.01.2020 16

Focus on fundamentals: virus volatility provides entry points for EM equities

Published January 30, 2020

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The essential

  • Overview: The coronavirus has been the strongest driver behind the recent volatility in financial markets, providing the trigger for a break in the rally in risk assets, which had been running uninterrupted since October.We should be aware that the trough for markets could be well in advance of the peak of the epidemic, as markets tend to overreact at the beginning of a crisis and then stabilise and rebound, despite the continuation of the negative news flow.
  • Overall assessment: Unless the “elevated uncertainty” is able to derail the global economy into a shock – which is not our scenario now – excessive downward setbacks in prices could provide entry points for asset classes with attractive valuations and good fundamentals. In particular, we see selective opportunities in EM equity given the reacceleration of earnings growth, attractive valuations and the prospect of a weaker USD. The short-term issue due to the Chinese situation is an opportunity to add to this asset class, barring any disruption to the global outlook.
  • Multi-asset view: Against the current backdrop, we believe that a diversified risk allocation could help investors navigate this phase of uncertainty. We have a risk-on stance, favouring European equity and European credit, as we believe that the economic picture has not fundamentally changed, but we believe that investors should keep (or potentially increase in the most conservative allocation) hedges against tail risks or reduce their exposure to a single risk driver. “Growth” is the main driver for markets now. To contain the volatility in portfolios by playing a cyclical rebound, we have downgraded to neutral our view on EM FX, which is more vulnerable to short-term volatility. This is a tactical assessment: this year we believe that EM FX will provide opportunities to investors once the situation in China normalises.
  • Emerging markets view: On the equity side, we have become more cautious on Chinese tourism-related sectors such as hospitality, aviation and consumer discretionary. However, we will continue to closely monitor quality consumer discretionary companies that could provide entry points should stock prices fall significantly. On the fixed income side, there will be some negative impact from weakening currencies, but this will be partly offset by the downward pressure on global yields. We think hard currency bonds are likely to be less impacted as the negative impact on spreads is likely to be largely offset by lower moves in core yields.
  • Global fixed income view: As the fundamental picture has not changed, we believe investors should remain focused on hedging key risks rather than changing their allocations on the back of a volatile news flow. We favour US treasuries, which are proving a good hedge as safe haven assets and have performed well so far. Investors should also favour currencies such as GBP and EUR, which have proved to be relatively isolated from the outbreak.


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