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Financial Industry Insights from Advisors Asset Management

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Going Viral


New concerns about the worldwide spread of coronavirus outside of China have led to the worst four-day run in the S&P 500 since December 2018.

What is the fundamental impact so far?

On Saturday, the IMF (International Monetary Fund) said that the disruption could cost global growth -0.1% to -0.15% this year (with risks to the downside if the crisis escalates). For China, it suggested a ~-0.4% hit.

We currently take a more conservative view. As things stand, we see a global growth hit closer to -0.3%, and impact on China of around -1%. The recent sharp rise in cases in Italy, South Korea and the Middle East means downside risks are also elevated in these economies but remain too early to quantify.

Of course, this remains an ever-changing and uncertain situation; a spread of the virus across Europe, the Unite States and elsewhere could result in months of elevated global growth risks.

The good news is that the situation in China (where 96%1of cases have been reported to date) appears to be stabilizing. A severe hit to Chinese Q1 (1st quarter) GDP seems inevitable, but the potential for a strong rebound in Q2 and Q3 can’t be ruled out.

Will the United States still grow around trend?

The United States has largely been driven by domestic consumption over the last year, so at present looks like one of the better-insulated economies. To date, there has been no evidence that consumption trends are being affected and so trend growth at around 2% still looks like a sensible (if tentative) base case for now.

As the United States imports about $320 billion of intermediate goods from China, further supply chain disruption is possible as China has not yet returned to full capacity. On the positive side, U.S. inventories are generally healthy as importers “front-ran” last year’s tariff increases.

We are keeping a particularly close eye on auto sectors in the United States, Japan, and Europe as they would potentially be the first to show obvious signs of disruption.

Is central bank easing more likely?

The most aggressive and immediate response will likely come from China, where we expect a combination of monetary and fiscal support to limit the GDP impact. In the United States and Europe, we believe there’s a higher hurdle for rate cuts, and further material downside risks would need be realized first.

New all-time lows in Treasury yields

In a flight to quality move, 10-year and 30-year Treasury yields fell to brand new all-time lows (Figure 1).

Figure 1: Record-low Treasury yields2

record low treasury yields
Source: Insight Investment | Past performance is not indicative of future results.

From a purely fundamental standpoint, this looks like an overreaction to us, but market momentum clearly favors lower yields. Furthermore, price action has suggested an uptick in unhedged foreign buyers as German bunds remain significantly above their all-time lows. More volatility is likely, and we would not expect to see a sharp reversal until markets can be more confident that the virus is being contained or can more concretely estimate the growth impact.

Only modest investment grade widening

U.S. investment grade credit was “priced for perfection” at the start of the year and has only widened by around 10bps (basis points) over the past two weeks. For us, this is not enough to make spreads look generally attractive, particularly as lower all-in yields likely mean less demand from yield-orientated buyers.

Figure 2: Modest reaction in U.S. investment grade3

Modest reaction in U.S. investment grade

Source: Insight Investment | Past performance is not indicative of future results.

Leave “no stone unturned” for value opportunities

We believe that investors will need to get creative to pinpoint value in credit. Any persistent impact from the virus will likely differ across sectors. For example, some consumer names may be able to capture pent-up demand, but travel and leisure sectors may face a permanent loss of revenue. Some credits will be better placed to weather the disruption.

Value therefore looks increasingly selective. We are finding that casting the net farther can open up additional opportunities in European credit as well as emerging markets and high yield (which have both seen more material corrections than investment grade credit).

This increasingly looks like a security selector’s market – we think investors will need to leave no stone unturned to pinpoint value in credit.

If you would like to read this Instant Insights online or any other literature, please visit our website.

1 WHO, CDC, ECDC, NHC and DXY, February 2020.

2 Bloomberg, February 2020.

3 Bloomberg, Bloomberg Barclays US Aggregate Corporate Index (average OAS credit spread), February 2020.

 

CRN: 2020-0225-8056R

The opinions and views of this commentary are that of Insight Investment and are not necessarily that of AAM.

AAM was not involved with the preparation of the articles linked to in this commentary and the opinions expressed in these articles are not necessarily those of AAM.


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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