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March 20, 2020
Coronavirus: At last - initial signs of credible action
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Coronavirus: At last - initial signs of credible action

Coronavirus: At last - initial signs of credible action

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March 20, 2020

 
 

Over the past week, we have begun to see greater global coordination, with G7 leaders agreeing to do “whatever it takes”1 , to support the global economy financially. Crucially, we have also started to see credible action by countries to control the virus. However compared with Asia, the delayed and until now, inadequate response by Western governments is in our view, the greatest weakness and means the economic impact will still be severe. Our near-term outlook for the economy is that it will become worse before it gets better. There is a high risk of technical recession in Europe, Japan and possibly the US, but we are cautiously optimistic in the long term. We expect to see a weak economic environment for some time, but fiscal stimulus should help the recovery.

 
 

The Federal Reserve has acted extremely aggressively, cutting rates twice in March and announcing a new $700bn asset purchase programme. With respect to monetary policy, there is little more that can be done, though some further liquidity tools may still be deployed. Though we believe decisive monetary action is important, this alone is insufficient and must be supplemented with coordinated and targeted fiscal policies. We are encouraged by the US’s focus on healthcare, supporting the unemployed, providing paid sick leave and a potential $1tn stimulus for households and businesses, as well as tax deferrals.

The European Central Bank (ECB) delivered a decent fiscal stimulus package and announced a €750bn asset purchase programme2. Whilst there was no rate cut, to spare the banking sector from additional stress, a borrowing facility for banks was provided with 25bps below the depo rate (a de facto more elegant rate cut).

The ECB confirmed they are ready to use all the flexibility available and can diverge from capital keys3 if needed.

It is essential that we see help for businesses, especially given the high levels of corporate debt. We believe that the aviation industry is only the first of many that will appeal for government bailouts. In addition, the plunge in oil prices, which are unlikely to rebound in the near term, has compounded existing global issues. In fact, we could see prices dip well into the $20s per barrel, before bottoming out.

In such a pandemic, appropriate public health management is key. Though the most dramatic initiatives by Western governments have been financial, we believe that the late and insufficient contagion controls are the reason the financial initiatives are not having more positive effects.

We are likely to see a lot of daily volatility for some time, even in safe haven assets such as gold, as investors seek liquidity. It is therefore still premature to begin even modest re-risking; we need to see a number of signs before we can consider this. In addition to monetary policy, liquidity injections and coordinated fiscal stimulus are key along with effective virus containment measures. We finally started to see some credible virus control actions being taken by Western governments, accompanied by steps to support the most severely affected people and businesses. How soon a treatment will be ready is still unknown, but we can see some positive development in that direction, even if it might still take some time.

We have provided the latest estimated asset allocation weights of each of our five Luxembourg SICAV funds in the following table, as of 18 March 2020.

 
 
 

Source: Global Balanced Risk Control team, Morgan Stanley Investment Management.

Allocations are subject to change on a daily basis and without notice. For information only and not a recommendation to buy or sell specific investment strategy. MS INVF standards for Morgan Stanley Investment Funds.

1. Volatility targets are indicative ranges. There is no assurance that these targets will be attained.

 
 

 

Tactical Asset Allocation Changes

Below we have provided an overview of our latest, key tactical asset allocation changes:

Equities

Europe: Moving from Neutral to Underweight
Compared with the US, we believe that Europe (along with Japan, which is already an underweight) is at risk of a recession for a number of reasons. Europe has a higher exposure to both tourism and manufacturing, both of which will take a large hit and are unlikely to bounce in 2020. This should exert a strong drag on growth as they both contribute substantially to European GDP. The US has greater exposure to services, which should be more insulated due to the ability to work from home and to generate online revenue. For similar reasons to Europe, Japan’s high exposure to manufacturing increases its risk of recession. Furthermore, earnings in the EU were weak to begin with, while the sector composition of the US Technology sector is likely to prove move defensive than European banks.

Autos: Removing the Overweight
Production is beginning to close in Europe and valuations are already at recessionary levels. However, there might be further downside as the situation escalates in Europe and the US.

Fixed Income

Peripheral Bonds: Initiating Underweight
Purely from the contagion angle, Italy is ahead of the curve, but our assumption is that Spain (and other countries) are just a few days or weeks behind, and that the situation is likely to deteriorate everywhere. Therefore, we underweighted countries in which the pain is still to be fully felt. The economic disruption will likely keep pressure on the spreads of these countries, during the market’s risk-off phase. Moreover Spain has more downside, whilst Italian spreads are already pricing in a lot more growth hit just because it is the eye of the storm at the moment.

 
 

 

RISK CONSIDERATIONS

There is no assurance that the Strategy 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 that the value of portfolio shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in this portfolio. Please be aware that this strategy may be subject to certain additional risks. TEquity and foreign securitieshere is the risk that the Adviser’s asset allocation methodology and assumptions regarding the Underlying Portfolios may be incorrect in light of actual market conditions and the Portfolio may not achieve its investment objective. Share prices also tend to be volatile and there is a significant possibility of loss. The portfolio’s investments in commodity-linked notes involve substantial risks, including risk of loss of a significant portion of their principal value. In addition to commodity risk, they may be subject to additional special risks, such as risk of loss of interest and principal, lack of secondary market and risk of greater volatility, that do not affect traditional equity and debt securities. Currency fluctuations could erase investment gains or add to investment losses. 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. Equity and foreign securities are generally more volatile than fixed income securities and are subject to currency, political, economic and market risks. Equity values fluctuate in response to activities specific to a company. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds ETFs and other Investment Funds, the portfolio absorbs both its own expenses and those of the ETFs and Investment Funds it invests in. Supply and demand for ETFs and Investment Funds may not be correlated to that of the underlying securities. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolio’s performance. A currency forward is a hedging tool that does not involve any upfront payment. The use of leverage may increase volatility in the Portfolio. Diversification does not protect you against a loss in a particular market; however, it allows you to spread that risk across various asset classes.

 
andrew.harmstone
Managing Director
Global Balanced Risk Control Team
 
manfred.hui
Managing Director
Global Balanced Risk Control Team
 
christian.goldsmith
Executive Director
 

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The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

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