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Covid-19  05/03/2020

Cornelian's views on the novel coronavirus infection outbreak

Our Chief Investment Officer Hector Kilpatrick outlines Cornelian's views on the global outbreak of the COVID-19 virus, what this means for markets and how our risk managed fund range is positioned accordingly.

Risk assets have underperformed materially since investors took notice of the fact that the novel coronavirus ‘COVID-19’ had started to take hold in geographies outside China. The sell off has been driven by investors beginning to extrapolate to the global economy what they have seen happen to the Chinese economy, as the authorities there undertake actions to control the spread of the virus.

Given the recent history of epidemics and pandemics, the base case has to be that the COVID-19 virus will be similarly controlled and, if you believe the numbers coming out of China, draconian quarantining is effective. However, we will only really understand whether their measures have been successful when the workforce returns to work and the authorities report the incidence of infections correctly thereafter.

In the northern hemisphere, one can take a degree of comfort that the traditional flu season will soon be abating and the rate of COVID-19 infection is likely to fall materially. This should buy time and investors are likely to take any such news positively. However, whilst most coronaviruses exhibit such seasonality, this is not always the case and so we will continue to monitor this assumption closely.

The southern hemisphere’s flu season peaks during our summer months and it is therefore likely that we will hear news of an acceleration of infections in countries such as Brazil, Argentina, South Africa, Australia and New Zealand during this time, which could hold back animal spirits as investors look to the northern hemisphere’s next flu season with a degree of trepidation.  

Whilst there is encouraging news about the development of a vaccine, it is unlikely that a mass vaccination program will be available to the general population within 12-15 months. This means that we may have another northern hemisphere flu season to contend with where COVID-19 continues to spread.

It is important to note that over time viruses can mutate and become more or less severe and therefore the impact of the COVID-19 virus during the next northern hemisphere flu season is impossible to predict. Importantly, it is probably fair to assume that a COVID-19 vaccination will be available for the general populace for flu seasons thereafter and therefore there is a shelf life to the current threat.

Looking through the narrow prism of investment, it is somewhat encouraging to see policymakers are beginning to act. The Federal Reserve in the US has cut interest rates pre-emptively by 50 basis points and other countries are cutting interest rates as well. These measures would ordinarily stimulate demand but do little to address the disruptions to supply. It remains questionable as to whether monetary policy can stimulate consumption in an environment when the virus is spreading and aggressive quarantining is in operation.

Far more sensible, in our view, would be for policymakers to continue to monitor the situation before introducing targeted fiscal policy stimulus to support banks, indebted companies and consumers if and when needed, as one of the major transmission mechanisms into the real economy will be via debt default and an impaired credit cycle, should the virus continue to gain ground. 

Nonetheless, the old truism that market participants stop panicking when policy makers start panicking usually holds true, whilst it is difficult to believe that interest rates can hold back the negative economic impacts of the virus. Hopefully, northern hemisphere seasonality will do the work of policymakers.

Having cut equity exposure across the risk managed fund range promptly (US, Japanese, Emerging Market and European ETFs reduced and, in the UK, selling Melrose Industries and top slicing Royal Dutch Shell), we are selectively adding to what we consider to be oversold positions in the belief that policymaker action allied with the usual northern hemisphere flu seasonality patterns, will provide something of a respite. In doing so, we are acknowledging that policymaker action is driving the risk-free interest rate down, which makes risk assets more attractive on a relative basis.

Furthermore, we had reduced our international equity sterling hedges to a minimum, and the funds’ asset values have therefore benefited from recent Sterling weakness.

Hector Kilpatrick
Chief Investment Officer

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