Coping with Coronavirus-Induced Market Volatility


Coping with Coronavirus-Induced Market Volatility

March 2, 2020

Jack Bailey: Hello and welcome to Talking Markets: exclusive and unique insights from Franklin Templeton.

I’m your host, Jack Bailey.

Transcript

Ahead on this episode: heightened market volatility following the spread of coronavirus. We’ll look at the growth slowdown, some of the biggest impacts, areas that may be more insulated than others, and policy responses that could help.

Gene Podkaminer, Head of Multi-Asset Research Strategies for Franklin Templeton Multi-Asset Solutions, joins me for this conversation.

Let's start with your overall view of what's transpired in the markets with the correction following the spread of coronavirus.

Gene Podkaminer: Well, sure. Let's talk about the big picture. There's been a lot of volatility in the markets. We've seen that, especially last week, but really building up to the way that the disease has spread around. So, we see a lot of heightened market volatility. We view this as a shock to growth and you can see that on both the demand side and the supply side.

What we've been saying, and not just us but many other practitioners for a long time, is that diversification is really important. It's always really important, but it's especially important in times of stress. And what we're seeing here is a lot of uncertainty leads to stress and so, of course, diversification will be really important. Another issue that this causes is many folks have emotional reactions to what's going on in the markets and what we would like to do is to disentangle the emotional from what's going on with fundamental economic drivers of returns. And in doing so, we really want to focus on that macroeconomic backdrop. That's where we want to lay our attention and we want to position our portfolios, not so much for the emotional impact that this has, but where we think the long-term opportunities are.

Jack Bailey: So, this is obviously had global impact. Let's touch on different areas around the globe. Let's start in China and Asia. What's your view of the impact there?

Gene Podkaminer: It's a good place to start, primarily because there's been so much virus spread—obviously in China, that was one of the origination points here—but also, because of China's manufacturing importance to the world, the way that it uses raw materials and the way that it exports finished goods. And also, the way that supply chains factor China into their equation. So, Asia is an interesting place to start also because you could argue it's a couple of weeks ahead of where we see the virus spreading to other developed and emerging economies. So, we've clearly seen a slowdown in Chinese economic activity. We see this through production indicators that haven't rebounded yet. We see this in business confidence surveys and we're also seeing that spread throughout the Asia Pacific region, for instance, South Korea and, of course, Japan.

So these economies are connected to China, the populations are connected as well through travel. And what you're seeing is a general slowdown in that region that's rippling across to Europe and eventually perhaps to North America.

Jack Bailey: Well, let me get you to expand a little bit about that. The impact in the US and in the eurozone. What are your thoughts about those areas?

Gene Podkaminer: So the virus impact is being, today, felt a bit more in Europe than it is in the US, there is a school of thought that it's just a matter of time before it is felt in the United States and Canada just as strongly. But from what we've observed in Europe, consumer sentiment, of course, is being hit. Labor markets, we think, may be fairly insulated, but we're keeping a really close eye on that. The bottom line is when we look at how supply and demand intersect and react in Europe, gives us a pretty good idea of how this may play out in other developed economies.

One point that I want to emphasize is, as we think about policy responses and when I say policy responses, I mean what do central bankers want to do about the situation with supply and demand? What do other policymakers that control fiscal policy want to do about the impact of supply and demand? The US and the UK are starting from a place of having more cushion in interest rates, which gives them more effectiveness in future monetary policy action. That's not the case in Europe. And so, that's one big difference that we see in the reaction function between what may happen in the US and the UK, versus Europe. And this also applies to some of the Asian economies, as well. So, when you look at what central bankers have to manipulate with rates in Japan, in China and South Korea, the picture is different from what policy makers have in the US, and fiscal policy as well.

You've already seen the beginnings of a fiscal policy response in some parts of the world. We'll see how that translates over to the US when the time comes.

Jack Bailey: Now in terms of duration, you know, historically we look at these types of events and they tend to be fairly short lived. Does the coronavirus feel different in any way?

Gene Podkaminer: The duration is hard to measure for this one because it's not clear how quickly, or when, supply and demand are going to rebound. A couple of weeks ago, you would see predictions of a very sharp recovery—so a drop in markets, a drop in asset prices commensurate with what's going on with global supply and demand and then predictions of an equally sharp uptick. Given what's unfolded over the last couple weeks, some of those predictions have been muted and so potentially this could take longer to work through the economic system then first appeared. We still think that much of the impact of coronavirus will likely be in the first and second quarter of this year and then a rebound in demand and supply later on in the year.

Jack Bailey: Now a lot of the actions taken so far like quarantines and travel restrictions, those have significant economic impact. Do you foresee these measures being taken as lasting a while or maybe being more short lived?

Gene Podkaminer: So, one episode that we can look back on in history is the outbreak of H1N1 in Mexico. And what happened during that episode was that there was a very high level of precautions taken, so limiting public gatherings, trying to really prevent the spread of H1N1. And what became clear in the aftermath was that the economic costs of those was inordinately high and ultimately the government decided to pull back in some of those very restrictive measures and let H1N1 run its course.

Jack Bailey: So with all that we've covered today, what is your asset allocation strategy in this environment?

Gene Podkaminer: So the context of it is that we go back to diversification and are looking at who has flexibility to respond to such a growth shock with flexible policy. The US and the United Kingdom are probably better set up from an interest rate perspective, than the eurozone is. So, the eurozone is quite constrained by the current monetary policy and also the fiscal challenges which could face a tougher road ahead if the virus was to spread a bit more broadly. With the range of uncertainties that we see now, it's hard to ignore that equities are risky, they are always risky. They may be a little bit more risky now, but also given the market corrections recently, potentially they are a tempting place to allocate into. What we're balancing that against is the short-term volatility that we may see, not just in equity markets but in fixed income and commodity markets as well.

But longer term, we are certainly aware that there may be some attractive return potential from global equities and that's on our minds, but we’re measuring that against this short term volatility that we see in the markets currently. So overall, we're trying to be nimble in the way that we manage multi-asset portfolios. We're aware of the longer-term equity potential, but also very cognizant of some of those shorter-term uncertainty that's still really hard to see through given where we are with the virus and the current cycle.

Jack Bailey: Gene Podkaminer, Head of Multi-Asset Research Strategies for Franklin Templeton Multi-Asset Solutions. Thank you for joining us.

Gene Podkaminer: Thank you. Wonderful to be here.

Jack Bailey: And thank you for listening to this episode of Talking Markets with Franklin Templeton. If you'd like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, or just about any other major podcast provider and we hope you'll join us next time when we'd uncover more insights from our on the ground investment professionals.

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