What are the key developments since last week?

• An acceleration of the number of infected people in the world, with a strong acceleration in Italy of 7, 000 cases, which is scrutinized as it may prefigure the acceleration path for other countries,
• Oil price free fall (-25% to -30%) due to the absence of agreement between OPEC and Russia, and willingness of Saudi Arabia to increase production volumes, leading to a -30% price on Monday morning,
• A liquidity stress on credit markets developed over the last days,
• Markets anticipate additional easing form central banks, with uncertainty of ECB internal alignment and remaining policy room, in particular on interest rates,
• Markets fell by about 5% on Friday and Monday’s opening of futures on Europe indicate another very difficult day, with a future on Eurostoxx 50 at -8%, and peripheral spreads attacked with Italy 2 year yield rising by +45 bp.

 

An uncharted territory

• We are entering levels of correction and volatility that rarely occur and that takes us back to 2008 on equities and to 1991 on oil price volatility,
• We are at maximum level of stress because we are at maximum level of uncertainties,
• This also reflects that investors’ anticipations are moving and adapting very fast; just two weeks ago, we had a few hundreds of cases in Europe, and we are now above 10, 000,
• This risk scenario has de facto become the central scenario of many investors from a macro and markets standpoint.

 

A global reset of risks

• In the most leveraged parts of the credit market, there is a classical loop playing: worsening of fundamentals, anticipation of increases in rating downgrades, normalisation of default rates triggering a reset of bond prices,
• A second loop kicks in: as in December 2018 or in January 2016, liquidity is very limited, in markets that had very narrow spreads, which amplifies the correction: some bonds lost as much or more than equities
• The third loop that developed in the last days is between a crash of oil prices and dislocation on high yield, as it occurred in 2015-2016,
• The stress on liquidity puts many investors in the psychological conditions of 2008,
• However we should refrain from comparing this situation to 2008: we have a decorrelation of risks but we do not have indicators of systemic risk flashing red at this stage.

 

What are the changes to our investment and market scenario?

• We confirm the idea that the shock on H1-2020 growth will be severe on European growth with a probable recession in Europe in Q2 if not already in Q1,
• Our central scenario with global growth below but close to 3% sees his probability reduced to 40-50%.
• The rising probability of entering in the risk case (global pandemic, generalisation of activity shutdowns) increases the chances of revising 2020 GDP growth to 2.5% or lower if a larger number of countries implementing radical preventive measures,
• We may continue to downgrade our 2020 EPS growth case that we had already revised negatively by c. 4 points,
• We anticipate that liquidity stress in credit market can increase refinancing risk and default rates in credit and that oil price drop will further harm high yield markets,
• We anticipate that the surge of volatility will drive both automatic selling pressure as well as panic selling,
• Safe havens such as gold and treasuries will continue to rise.