Insights
Update on Coronavirus and the Markets
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Market Pulse
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March 02, 2020
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Update on Coronavirus and the Markets
Update on Coronavirus and the Markets |
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Markets had their worst week since the financial crisis of 2008 this week, and the 10-Year Treasury Note hit historic lows, as the Coronavirus continued to spread across the globe. By now it’s clear the virus will have at least a short-term impact on the global economy. The question is, how do we as fixed income investors move forward?
The Known Unknown: Is that it is uncertain how long this virus will disrupt economic activity in the U.S. and globally. What is known? This is not yet a systematic crisis. We know what the issue is; unlike other crisis events where it was harder to identify what the linkages were for economic weakness.
We believe the Fed is priced 100% for a 25bp cut in March, and that 50 bps may be forthcoming by the end of the year if economic conditions do not stabilize. This would be good for sentiment and stabilization of equity and credit markets, even if it does not directly help the economy.
The key risk is credit. For this we apply an AAA framework – Affordability, Accessibility, Appetite
o Affordable. The Fed likely to cut rates. This can help keep corporate borrowing rates low
o Accessibility. Will technical/structural factors enable corporate borrowers to issue debt?
o (Risk) appetite. Will there be demand for buying corporate bonds?
The second and third points are connected. We believe if all three of the AAA framework are working, then we can expect a sharp recovery. If not, then the recovery may be prolonged and this could lead to a deeper slowdown.
Portfolio Positioning
Marginal changes to portfolio positioning
· Increased total duration
· Reduced Emerging Markets risk
· Reduced Spanish and Greek duration
· Mitigating risk on high yield
· No changes to securitized exposures
When would we look to add risk?
· We need to see the cases of newly infected people stabilize in the U.S. Right now, the spread of the virus has been well contained but the fear is that we go through a cycle like Italy and South Korea, where the number of infected people numbers start slow and then ramps up quickly.
· Models suggest we should see a spike in cases starting next week. That’s what the market is focused on right now. Once the number of cases stabilizes, which seems to be what’s happening in China, it will likely be a good time to add risk.
· Would look to add risk in high yield and emerging markets
Risk Considerations
There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default, and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities purchased by the Strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. High-yield securities (“junk bonds”) are lower-rated securities that may have a higher degree of credit and liquidity risk. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. Foreign securities are subject to currency, political, economic and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Sovereign debt securities are subject to default risk. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk).