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Asset Allocation Update: Corona chaos

25 February 2020

Spread to Europe

Having started in China, the new coronavirus has been spreading to more and more countries recently. In our monthly Asset Allocation update of February, we discussed the damage of the coronavirus to the Chinese and other Asian economies. In any case, as far as growth perspectives are concerned, the first quarter of 2020 can be considered ‘lost’, with China presumably showing economic contraction compared to the last quarter of 2019 and the worldwide growth momentum being cut in half. Increasing numbers of companies are reporting out-of-stock issues and production delays. The number of new cases reported in China seems to be dropping now, but there is no telling whether this drop will continue, nor when the lion’s share of Chinese workers will return to work. The word from China is that large numbers of factories are reopening, but we can gather from information that is accessible on a daily basis, concerning air pollution and length of traffic congestion, that production is still very low.

This weekend, South Korea saw an alarming rise in coronavirus infections, and the large number of people who tested positive for the virus in Italy shows that Europe is not immune to the problem. Strong measures are being taken. Public buildings are closed and northern Italy, the region with the highest economic activity, is on lockdown. Now, of course, many companies would have been closed in connection with public holidays even without the coronavirus outbreak. Incidentally, the first contingency measures in China also coincided with a holiday period; that of the Chinese New Year. It speaks for itself that protracted periods of economic disruption will have grave economic consequences. For the time being, it is hard to predict how grave the impact will actually be. Recent confidence barometers for Europe and the US suggest that the impact so far is not as bad as we may have feared, but perhaps it would be wise to monitor daily reports on new infections rather than these data from (albeit recent) history.

The impact on financial markets
On the surface, the financial markets appeared to be little affected by the virus in recent months, contrary to what newspaper headlines may have suggested. Even after today’s correction, all stock markets trade near record highs. Expecting the virus and the corresponding economic damage to be short-lived, investors, for now, do not seem too worried about an imminent economic recession. This is partly due to the fact that most of them are quite confident that central banks will lend an extra helping hand. As a result, global risk-free interest rates dropped significantly. Traditional safe havens like the US dollar and gold increased in value. Equity markets also show clear shifts, with valuation differences between sectors reaching disturbing proportions.

We take profit on debt securities of European companies
For some time now, we have taken a cautionary position as far as equities are concerned. We feel that future company profits are overestimated. We do hold a fairly large position in debt securities of European companies. In the past few months, this has contributed to successful portfolio returns, as both interest rates and risk premiums decreased. In view of rising insecurity about economic prospects, we have decided to take part of the profits. The proceeds will be held in cash for the time being. 

Kempen Capital Management N.V. (KCM) is licensed as a manager of various investment funds and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets. This information may not be construed as an offer and provides insufficient basis for an investment decision.

The Asset Allocation Desk

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