To be clear, there are no winners if coronavirus continues to spread.
However, as bond investors it behoves us to make a realistic assessment of how assets will perform under a pandemic scenario. This then allows us to take prudent steps to immunise portfolios as far as possible.
Stating the obvious to an extent, government bonds will continue to perform well – or very well – under such a scenario. The US 10-year yield is pushing towards record low levels, despite the prevailing economic data coming out of the US continuing to be reasonably firm. However, while current levels are not underpinned (thus far) by observed economic data, we should expect these bonds to continue to outperform in a pandemic scenario.
Domestically-focused entities may also be more insulated. With companies continuing to report fourth-quarter results, many of those exposed to China specifically – and more generally global demand – have sounded the alarm. In many cases, CEOs continue to expect a recovery to come through and benefit numbers in the second half of the year. However, for those that are globally exposed, the uncertain trajectory of infection is likely to lead to investors seeking safety elsewhere.
For example, early indications are that the utilities sector will be a relative outperformer. This may be attributed not only to their domestic focus, but also to their bond-proxy characteristics. These are likely to offer stability, and are beneficiaries of lower government bond yields. On a case-by-case basis, of course, these characteristics are also shared by some names in the telecommunications sector.
On the flip side…
Cruise lines, airlines, conference providers and international hotel groups will suffer. In many cases the business model involves attracting customers from all over the world and placing them into close confinement (though often luxurious in nature). Historical references to cruise liners as floating petri dishes have garnered much publicity of late.
The auto sector remains heavily reliant on China as a growth engine. As the virus has escalated, we have seen supply chain issues (with Jaguar Land Rover reportedly flying parts out of China in suitcases to factories in the UK). We have also seen some early warning signs on the demand side of the equation, with reports of China’s car sales falling 83% year-on-year for the seven days through to 23 February. While car purchases are more likely to be delayed than cancelled, one tends to go to a showroom in order to buy, and the early signs are that in China, consumers are unwilling or unable to do so.
And lastly, there are catastrophe bonds with high yields (and in many cases, high yield ratings), with payment at maturity linked to the absence of a so-called catastrophe event. In 2017 the World Bank issued two tranches of pandemic (catastrophe) bonds, which default under a defined pandemic scenario (as funds are used to deal with the fallout of said pandemic). These bonds are set to mature in July, unless the scale of the outbreak is such that they are triggered (read default). Needless to say, we are not holders.