Coronavirus: markets take fright – what lies ahead?

Until late February investors had been happy to largely brush off fears of a global pandemic, working on the assumption that as long as a broader outbreak of the coronavirus outside of China was avoided, the impact on global economic growth would not be too severe.

Buoyed by this and the continued provision of liquidity from central banks, the view was that the global economy should avoid slipping into recession in 2020.

However, with the accelerating growth of clusters of coronavirus infection outside China (notably in Japan, South Korea and Italy), the risk of a more substantial slowdown has risen and investor sentiment has turned.

From 21 February to 28 February the S&P500 fell approximately 14%, recovering initially in early March, only to fall again heavily on 5 March.

Defensive assets including government bonds, the US dollar and gold rallied as investors rushed to allocate to perceived "safe havens".

Markets took the virus in their stride – until the recent spread beyond the borders of China

As investors reassess the potential impact of the coronavirus on global growth and financial markets, we want to outline our current positioning and what might cause us to change our thinking.

We continue to monitor the impact on earnings and global economic data

We expect that data for the first two quarters will be softer as a result of the coronavirus, with signs of recovery as we move into the second half of the year.

The risk remains that the spread of the virus outside of China will more meaningfully disrupt global supply chains and we therefore see the possibility of softer economic data later in the year. Governments and Central Banks would be expected to respond in this situation as it would otherwise increase the risk of recession. An increased likelihood of recession could lead us to reassess our risk exposure.

Our equity allocation

Our base case remains that the virus will ultimately be contained and that although global growth will take a shorter term hit, it should snap back.

The potential impact of the coronavirus aside, the overall state of the global economy looks to be in a reasonable shape following the recent quarterly corporate guidance as well as the expectation of greater fiscal spending globally. Continued large injections of liquidity from central banks should benefit risk assets.

Volatility levels are likely to remain elevated

Compared with the start of the year, uncertainty levels have risen considerably – uncertainty about supply chains, final demand and input prices, all of which translate into uncertainty about profit margins and earnings. We feel portfolios are reasonably positioned to deal with volatile market conditions and afford us the option to wait for more and better information upon which to base any future investment decisions. Short-term market timing around risk events in the absence of meaningful information has proven to be difficult and not necessarily beneficial to returns.

In this environment, the option to wait is valuable, a fact worth remembering as coronavirus fears continue to obscure the outlook in global markets.

We continue to favour an allocation to alternative assets including gold

These have historically defended capital in periods of market volatility. While gold has performed well already this year and now sits close to seven-year highs, we are happy to maintain our holding, particularly considering the rich valuations of government bonds.