There’s Nothing Like a Pandemic Scare to Test Analysts’ Acumen

(Bloomberg) -- Market strategists are assessing the damage wrought by last week's coronavirus-induced turmoil and what it means for trading in coming months. It's not pretty.

Investors see an “impossible trade-off” between a pandemic-induced recession on the one hand, and a recession due to “draconian quarantine measures” on the other, according to Bank of America Merrill Lynch. It recommends staying bullish on bonds just in case.

The spread of the virus encapsulates a strategist's worst nightmare -- how to advise for a so-called black swan scenario, a surprise event that wreaks havoc across markets. Reputations can be made or broken, forecasts will have to be rehashed and trade recommendations carefully thought through.

“Black swans typically unfold in one of two ways: explosively with an immediate change in the outlook; or in a slow moving ‘train wreck' fashion where the market comes slowly and progressively to the realization of the magnitude of the events unfolding, as in the 2007-08 crisis,” wrote Bank of America Merrill Lynch strategists Bruno Braizinha and Ralph Axel in a note. “There may be significantly more downside in risky assets from here.”

Banks have been left licking their wounds. Citigroup Inc. admitted its tactical short recommendation on U.S. rates last week had “misfired” as Treasury yields slumped to record lows. They now say global recession this year is “extremely likely.”

Much rests on what global central banks decide to do. Goldman Sachs Group Inc. economists expect the Federal Reserve to cut interest rates by 50 basis points this month, with the possibility that other global institutions could move in lockstep. If so, it would be the first coordinated move of its kind since October 2008.

That prospect led yields to plummet again Monday, with those on two-year Treasuries dropping as much as 21 basis points to 0.71%, the lowest level since 2016. Those on 10-year German bonds dropped toward record lows set last year.

Morgan Stanley strategists are looking for any signs that central banks will move in unison, and say risky assets will probably continue falling in the “absence of a timely response.” The bank is turning to its “CRIC cycle” model, which identifies phases from a crisis to response, to improvement and then finally to complacency -- without intervention, the next step is a return to crisis, the bank said.

“Tighter financial conditions around the world, driven by the spread of COVID-19, are placing help wanted ads in both monetary and fiscal newspapers,” wrote Morgan Stanley strategists led by Matthew Hornbach in a note to clients. “Life at the all-time lows can be volatile.”

Playing Safe

Not all strategists are so pessimistic. While NatWest Markets has cut its forecast for the euro area so that it now sees zero growth in the first half of 2020, it sees China's infection rate slowing and business activity in the country picking up.

The crisis may see fiscal stimulus come to the fore too, while central banks -- especially the European Central Bank -- hold fire. Still, the bank continues to recommend a long position in U.S. bonds.

For now though, most strategists are playing it safe. Those at JPMorgan Chase & Co. are recommending that investors “cut risk” until markets settle. The bank closed its overweight call for Italian bonds after 10-year securities had their worst week since November.

“We sharply reduce risk across the board,” wrote strategists Fabio Bassi and Antoine Gaveau in a note to clients. They see “markets in proper panic mode.”

To contact the reporter on this story: John Ainger in London at jainger@bloomberg.net

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Neil Chatterjee

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