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What should investors do is on the lips of every market participant/advisor. An extremely hard question to answer with certainty but the following thoughts may help to provide some clarity on an obviously fluid and fast moving situation:

When will investors believe the measures taken will control the crisis on a number of fronts: medically, economically, and in a financial sense? When this occurs investors will be able to look across the valley or abyss and absorb bad news which is yet to come.

A clear concern is voiced for the longer-term in the Ferguson report from Imperial College London which argues suppression measures can control the virus in the short-term, but if relaxed will result in a second wave. This if it occurred would leave economies in a depressed situation and markets would have another leg down, even from levels of up to 35% below peaks. This would be a global depression scenario.

Most countries, hopefully including the United States, are putting in place measures which are now more sensible in terms of their ability to provide economic support. These have been framed on the basis there will be a short sharp hit to the global economy and these measures will safeguard the solvency of individuals and businesses.

Looking beyond the measures to suppress the spread of the virus, investors will monitor whether the relaxation of rules will then see a rise in the transmission rate. Not all medical experts believe suppression if relaxed will see an increase in the reinfection rate often referred to as r to above one. Some governments may tolerate a modest rise in the transmission rate to allow the economy to function better. Some medical experts are floating the idea of utilising limited herd immunity. This would involve identifying a pool of workers, who having tested positive but then recovered can work normally as they should not get re-infected. This would be most valuable in healthcare, but could be applied across a number of industries and allow a phased return to some form of normalisation. It requires widespread testing as many people may have the virus in such a mild form they do not realise it (as discussed in previous article). On the vaccine front the first progress could be on a passive vaccine effective for a very limited time period say for a couple of months, but which could be repeated.

Today in China if the data can be believed it does seem that case numbers though still increasing are under control and still improving. Whilst Hong Kong and Singapore have seen a new spike in cases this is blamed on returning nationals in the main. Restrictions have been reintroduced to nip this in the bud and governments in the west may need to act swiftly and flexibly going forward as and when new case numbers slow. The west will find it hard to emulate the draconian measures China used to slow the infection.

There has also been speculation markets might close and this has happened in the Philippines and is not without precedent in many emerging markets. If this did occur it is unlikely they would be allowed to reopen unless news was significantly better so would gap up not down on the reopening.

There are also studies suggesting investor sentiment has reversed course from the bull market and that risk parity funds have extremely low equity content and CTAs are net short equities. Overall quant strategies are short equities and a rally could result in a rapid unwind of these negative positions so at some point there will be a very sharp rebound. Whether this is a bear market rally or something more sustainable will depend on a number of factors but is likely to be meaningful nonetheless. Investors have now witnessed one of the fastest declines in stock market history admittedly on one of the biggest threats the market has faced.

Markets could well see an initial rebound when the US fiscal package is passed, especially if it is larger than expected. However if the US does not tighten up restrictions and case numbers continue to rise this will be hard to sustain. The trigger for an initial meaningful rally lasting more than a few days is likely to be signs of peak intensity in the west. The Ferguson report argued this would occur in terms of a fall off in demand for critical care beds three weeks after suppression was introduced. Other estimates suggest a slightly longer timescale but new case numbers should slow after that three week period. After the measures in the UK announced yesterday it is possible to put a timeline on this in that country (If London adheres) although the situation in the States is harder to judge with certainty as different states and cities are adopting contrasting action plans and the US President has even hinted at a relaxation of rules on social distancing. At the moment estimates suggest that only around 42% of the US population live in areas where restrictions or suppression measures have been put in place. Investors will have to weigh up the possibility of lower markets before this decline in numbers is reached versus the prospects of a sizeable rally even if it is only a bear market rally when news improves. A long-term rally (the start of a new bull market) will need evidence that suppression can be relaxed without a massive spike in the re-infection rate or a vaccine emerges that is widely available.

Strategy Team IRC 24.03.20