Modest risk reduction, looking for entry points
Clearly, the main risk now is the unwinding of recent market complacency and the reaction of “animal spirits”. The good run in risky assets has been driven by investors who believe (1) the Covid-19 episode will be temporary (our central scenario); (2) a worsening situation will trigger more Central Bank (CB) action; (3) they have no alternative, given the moves of safe-haven assets. Therefore, we can expect to see some profit-taking, short-term market volatility and overreaction.
A tactical move towards neutrality in risk exposure and an increase in hedging looks to be a good strategy to navigate this phase. Beyond that, Covid-19 must be seen as a way to implement our investment convictions, exploiting entry points in some areas of the markets such as the cyclical value component in European equities (already attractive, but even more so now), EM equities (help-yourself-countries or domestic-demand stories) and EM currencies. All these stories will be back in focus once the virus-headlines recede. In addition, falling core yields will likely reignite the search for yield in credit or in higher-yielding government bond space in EM and DM (e.g. Italy). We should also not underestimate the fact that if the situation worsens, CBs and governments could start to use stimulus on a massive level, renewing the narrative of bad news is good news. Fed’s recent inter-meeting emergency rate cut of 50 bps is a step in that direction.