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Wed 1 Apr 2020 08:58 AM

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Reassuring investors in a time of uncertainty

Governments require a multi-pronged policy to mitigate economic impact, writes Zainab Kufaishi

Reassuring investors in a time of uncertainty

Zainab Kufaishi, Invesco’s Head of Middle East and Africa

The spread of COVID-19 has shaken global markets and has put strain on most economies.

Equity markets have fallen steeply in the past week, the US Treasury bond yield has also dropped to an all-time low; tourist and business travel have been severely affected due to restrictions, and large events and conferences around the world are either cancelled or postponed to limit the spread of the infection.

While markets in China have been impacted since early this year, global investors only started reacting to the news about coronavirus since the end of February, and the response has been rapid.

We would not be surprised to see the sell-off continue, given the uncertainty about the virus and how it evolves over time. Therefore, accurately forecasting the impact and outlook is a challenge, and investors react negatively to uncertain market conditions.

Disruption of global supply chains

Global supply chains have been severely disrupted given much of the production of goods originates in China, or broader Asia, which of course has downstream implications for not only the supply of goods but also the payment for goods. Many important components for manufacturers across the world are built in Asia – from high value-added goods such as electronics, robotics, automotive components and luxury fashion items to low value-added goods such as affordable garments, toys and household goods.

Not only has there been a slowdown in manufacturing and the delivery of goods because of factory slowdowns, or shutdowns, but the payment chain has also been affected. Naturally, a reduction in the growth rate of infections would be one catalyst driving an upturn.

Governments require a multi-pronged policy to mitigate economic impact

An appropriate multi-pronged policy response could trigger an upsurge. Several governments have begun implementing healthcare policy responses to contain the spread of the virus. We have also seen changes in monetary policy being implemented both in the region and globally. Many of the region's banks are announcing interest rate cuts, after the US Federal Reserve made its widest benchmark rate slash since the financial crisis of 2008.  Governments have also now begun to introduce several fiscal policy measures.

A pandemic, as we are seeing now, usually generates an economic shock first on supply, not demand.  Businesses are suffering as workers are out of work, and they cannot meet their obligations. China, for example, called on lenders not to classify overdue loans as bad debt for companies struggling through the crisis.

In the UAE, the latest measure adopted by the Central Bank announcing a Dh100 billion-stimulus package is a welcome move and will support retail and corporate customers overcome financial constraints due to the virus outbreak.

Such fiscal policy response, combined with monetary and healthcare policy responses, provides much needed support to keep businesses and people who have been financially impacted because of loss of work, afloat.

Earnings recovery in Chinese equities in the near future

As we have seen, the Chinese economy came to a virtual standstill in February.  Now, we believe there is light at the end of the tunnel for China as they are on the other side of the crisis and are seeing a reduction in the growth rate of infection and operations are ramping up again.  Chinese authorities have sacrificed the majority of first quarter economic activity as they implemented measures to contain the virus through monetary and fiscal stimulus, and we should expect to see negative data points coming out of China in the near term.

However, the epidemic in China is no longer escalating and we are witnessing the government starting to restore economic order. There is a sense of normalcy returning. We should expect to see an earnings recovery in China equities first.

Need for more liquidity in the market

An interest rate cut alone is not enough to achieve what is required by the market. At Invesco, we believe that a better response would be to supply liquidity to deal with the panic. Monetary policy is not just about interest rates – it is about providing the right quantity of money and supplying adequate amounts of funds.

The Fed should also look to supply liquidity to deal with the panic. This could be done by purchasing bonds, treasury bills, repo transactions, or even expanding dollar swap transactions with the central banks in Asia. When the situation normalizes, the liquidity can be withdrawn to avoid having excess funds in the market, which would otherwise lead to inflation.

The vast majority of our investors have a long-term horizon with their investments. This enables them to withstand the kind of market upswings and downswings that we’re experiencing now.

We have seen and lived through significant downturns in the market in recent years, as recent as late 2018 with severe impact across the board, attributed to the trade wars, US political turmoil, the partial government shutdown, weaker Chinese economy, lower than expected earnings in tech and inverted yield curve in the bond markets.

Stocks have a tendency to rise over time, with the rise in economic growth trajectory as the result of innovation and improvements in production, which benefits long-term prospects.

For investors this is an opportunity to look for buys, and to ensure their portfolio exposure remains well diversified.

China is on the other side of the crisis, as it is seeing a reduction in the growth rate of infections. Chinese equities and global equities with exposure to China revenue are favored given earnings will likely recover first in China, in our view. Exposure to alternatives including real estate and gold also remains important.

We will get through these challenging times by applying the same key principles we have applied in each of the other crises and bear markets of our multi-year investment horizons: think long term and stay the course.

Zainab Kufaishi, Invesco’s Head of Middle East and Africa

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