A Wall Street firm lists its 5 best hedges for an unusual coronavirus-driven market crash - and shares what to do if it's successfully contained
- Global markets have largely dismissed the economic ramifications of the coronavirus outbreak and continued rallying to record highs.
- According to Alan Ruskin, the chief international strategist at Deutsche Bank, investors should be putting their portfolio-protection strategies in place because there is sufficient risk the outbreak becomes "an unusually large disruptive market event."
- He listed five hedges, and also advised on what to do if the economic damage is not as bad as feared.
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Global markets have largely shrugged off the second-order financial impact of the coronavirus outbreak and continued marching to new highs.
As of Wednesday, the death toll had reached at least 1,117 with more than 45,000 people infected. But markets soldiered higher amid a rosy corporate-earnings backdrop and signs that the infection rate was slowing down.
The reality is that investors will have more existential things to worry about than just their portfolios if the outbreak spirals out of control. But barring this extreme scenario, markets can still quake at the financial toll the outbreak has on China, the crisis epicenter and world's second-largest economy.
Alan Ruskin, the chief international strategist at Deutsche Bank, described such a market sell-off as a "fattening tail risk" - a statistical reference to outcomes that are distant from the norm.
"There is enough of a probability that the coronavirus becomes an unusually large disruptive market event that it warrants PMs taking a close look at potential hedges against this 'fattening' tail risk," Ruskin said in a recent client note.
He offered five strategies for portfolio protection in the event that China fails to contain the virus domestically within weeks and other economic powerhouses are disrupted. His recommendations are listed below in descending order of his confidence in them.
1. Long duration: There will be a flight to the most liquid G10 bond markets in the event of an economic scare, and so betting on these fixed-income securities is advised. Treasuries are considered the most secure of them all.
2. Front-end rate receiver trades: These refer to derivative contracts that are hinged on changes in short-term interest rates. As it stands, several G10 central banks can and likely will lower interest rates to combat a global economic slowdown, although a fiscal response may also be required.
3. Commodities: Gold will appreciate even if it doesn't surge, Ruskin said. But avoid base metals like copper and zinc, as they are a popular short trade for cyclical downturns.
4. Stocks: From a micro standpoint, avoid stocks that are exposed to the immediate aftermath, such as airlines and cruise liners. On macro level, Ruskin expects US stocks to be more resilient than their emerging-market counterparts as long as lower interest rates create easier financial conditions.
5. Long volatility across all asset classes. The currencies market stands out here for having extremely low volatility, and Ruskin flagged USD/CNY as a pair with solid upside risks.
With the hedges established, it is also important to consider what happens if the coronavirus is brought under control. Ruskin provided the following pointers:
- Base metals could reverse some of their recent losses relatively quickly.
- Gold won't suddenly lose its appeal - it will still be demanded a hedge against risks that are independent of the virus.
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