Coronavirus reshapes our investment themes

 March update

The coronavirus pandemic is set to deliver a sharp and deep economic shock. Market moves are reminiscent of the darkest days of the financial crisis, but we don’t think this is a repeat of 2008. Stringent containment and social distancing policies will bring economic activity to a near standstill, and lead to a sharp contraction in growth for the second quarter. However, provided bold policy actions are taken to bridge households and businesses through the shock, activity should return rapidly with limited permanent economic damage. This includes drastic public health measures to stem the spread of the infection, as well as coordinated monetary and fiscal policies to prevent disruptions that could cause lasting economic damage.

We see encouraging signs from major central banks and governments that such a monetary and fiscal response is starting to take shape. The pledged policy response has been swift – and we expect total fiscal stimulus to be similar in size to that of the global financial crisis but compressed into a shorter timeframe. Recent policies by Australia, Canada and the UK are the type of coordinated monetary and fiscal action that we have flagged a need for in dealing with the next downturn. While the shock is of unknown depth and duration, what we do know is that the containment measures and social distancing mechanically bring economic activity to a halt. The impact on economic activity will likely be sharp – and deep. And virus fears have led to a sharp tightening of financial conditions – and plunge in growth expectations. See the chart below. We see the shock as akin to a large-scale natural disaster that severely disrupts activity for one or two quarters, but eventually results in a sharp economic recovery.

Virus fears are tightening financial conditions
BlackRock U.S. and euro area financial conditions indicators, 2010-2020

Markets, in our view, will ultimately settle down if three conditions are met: 1) visibility on the ultimate scale of the coronavirus outbreak and evidence the infection rate has peaked over the long term; 2) deployment of credible and coordinated policy packages; and 3) confidence that financial markets are functioning properly. Once we better understand the scale and impact of the outbreak, the policy response is setting the stage for an eventual – and strong – recovery. We stay neutral on risk assets and believe investors should take a long-term perspective. For some investors this may include rebalancing back toward benchmark weights, as the scale and rapidity of market moves have likely left many portfolios effectively overweight bonds and underweight equities.

We emphasize portfolio resilience through a benchmark allocation to government bonds, quality equities, cash and sustainable investing. We prefer geographies with the most policy space – such as the U.S. and China in both equities and credit, and favor quality exposures. In equities, we have upgraded the U.S. market both because of its quality bias and expected fiscal stimulus. We move to underweight Japanese equities because the outbreak’s impact adds to the earlier economic damage of a sales tax increase. In fixed income, we have reduced Treasury Inflation-Protected Securities (TIPS) to neutral after a huge decline in rates, though we still see value in the long term.

Over a longer horizon, this pandemic adds to the trade tensions in compelling companies to rethink their global manufacturing footprints. This combination of supply shocks could weigh on growth, increase production costs, pressure profit margins and drive up inflation.

View our March update in charts