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Q2 Outlook: a world out of balance

5 minutes
THU 02-04-2020
“The virus outbreak has set three major macro impulses in motion: a global demand shock, a global supply shock and an oil war that has forced prices to multi-year lows. This final development will result in an enormous destruction of capital and, soon, structural unemployment.” says Steen Jakobsen, Chief Economist and CIO at Saxo Bank.

“The triple hit to the global economy almost guarantees 2020 will be a lost economic year, with policymakers needing to pull out all the stops to address a real, global recession.

“This current disruption has already eclipsed the 2008 chaos in some markets, as we suddenly find ourselves in a period in which some markets can move up and down more in one day than in an entire year and reflects how illiquid markets are.

“In an environment of panic deleveraging, the ‘cash is king’ mantra arises. Funds, banks, investors and even companies suddenly see not only a dramatic mark-down of asset prices, but wild swings in correlations across portfolios and swings in P&L.

“Central banks, meanwhile, try to move in quickly with ‘support’ in the form of rate cuts and liquidity provision. For a company or fund relying on credit for some portion of its operations, this may help in terms of the future cost of financing liabilities. But it does not help the price of the equity or credit on the asset side, causing significant numbers selling
assets that are often highly illiquid to deleverage across the board.

“This cycle is even worse than ones we’ve seen before because of current low and negative yields have triggered a ‘reach for yield’ that forces market players further out on the risk curve and into super-illiquid financial assets such as private equity and high-risk corporate credit.

“We are therefore now in an environment of more price discovery, which will mean significantly higher volatility and a cleaning out of models for the valuation of private equity and other high-risk assets that are predicated on low interest rates, central bank intervention and a somewhat naïve assumption of multiples that can go up forever.

“The shakeup we are seeing here in Q1 will change the landscape of investment and risk tolerance going into 2021. It will also change the long-term allocation model away from a 60/40 bond/equity allocation to proper hedging through commodity exposure and long volatility.”

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