Friday, March 20th, 2020

Asia: First In, First Out

There are two parts to our note this week: the Great Volatility Spike and the Pivot to Asia. The first is a description of just how serious this crisis is; the second is a message that even in the middle of the disaster there are signs of hope and emerging buying opportunities.

Every week we publish an index which tracks the realised volatility of 11 major financial assets. The measure is based on the weekly total returns in US$ for the last 26 weeks and each asset is equally weighted. Each asset is benchmarked to its own median volatility over the life of the model and the whole thing is plotted on a log-scale, which has the effect of giving equal prominence to periods of unusually low volatility as well as the inevitable spikes, which are the whole point of the exercise. It sounds complicated, but the chart is easy to interpret.

The recent spike in the index is already as big as the one which occurred during the GFC – and this one clearly isn’t over yet. In the space of three weeks, it has gone from a level of 0.83 (below median) to 1.95 – an increase of 135%. During the GFC, the index peaked at 3.93 which was an increase of 176% from its undisturbed level, but this increase took 30 weeks. If we just look at the worst part of the GFC, the increase was 142% over a period of nine weeks. This shock is already as big as the worst part of the GFC and it has happened three times faster. On that basis, the total fiscal and monetary response is going to need to be at least three times bigger than the GFC.

While we are waiting for the politicians and central bankers to catch up, we should make time to ask where we are going to invest this wall of liquidity when it finally arrives. The obvious strategy is to buy those assets which were the most volatile on the way down. But while that may produce some big headline returns, they may not look so good on a risk-adjusted basis, and they may not happen at all. The best risk-adjusted returns will probably be achieved by those countries and sectors which are already producing them.

In the US, the Technology sector is still close to maximum overweight. Many of the leading companies may have fallen in line with the index, but they had gone up more before the crisis and have structurally lower volatility. They also tend to be less reliant on the investment grade and high yield bond markets, where we continue to expect a series of aftershocks.

Outside the US, we prefer to respond on a country basis. The corona virus affects countries first and industries second. As of this week, the top ranked country in our global equity report is Taiwan, followed by China #2 and New Zealand #3. Next there are two European countries, Denmark #4 and Switzerland #5, which have high exposure to the healthcare sector. The rest of the top 10 is dominated by Asia – Japan #6, Malaysia #7, Hong Kong #8, Korea #9. China now reports no new domestic infections from the corona virus; Taiwan was hardly affected. South Korea was but already has a lower death rate than Italy, Spain, France and the UK. Looking forward, these economies face a much lower level of financial and economic dislocation than the West. By the time investors are ready to buy the bounce in Europe or the US, they may have missed it in Asia.

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