COVID-19 could put a stake in heart of ‘buy the dip’

The new coronavirus sweeping the globe since the start of the year could knock investors' go-to strategy for risk-off markets over the past decade — buy the dip, with a focus on U.S. equities — off its pedestal, analysts say.

In a worst-case scenario of countries beyond China, the virus' epicenter, having to follow its lead in shutting down material chunks of their economies to control the outbreak, the monetary policy elixir the U.S. Federal Reserve and other central banks have been serving up could fall flat, they predict.

This is not a typical "buy the dip" situation, given the significant uncertainty around the path of COVID-19 and its impact on economic growth and earnings per share, said Erik Knutzen, managing director and chief investment officer-multiasset with New York-based Neuberger Berman Group LLC.

Wild market gyrations over the two weeks through March 6 — a period that saw investors' first attempts to discount COVID-19's likely impact on U.S.-listed companies — suggest clarity is in short supply just yet. The market — after an initial week that saw the Dow Jones industrial average plummet more than 12% — took on a manic-depressive feel for the week that followed, with more than 1,000-point gains on March 2 and March 4 interspersed with declines of roughly 785 points on March 3, 970 points on March 5 and 257 points on March 6, for a 10.8% fall over the two-week period.

"It will take months for investors to gain clarity on this and over that time period, we expect volatility to remain elevated," Mr. Knutzen said.

Investors accustomed to central banks injecting liquidity into the system at any sign of market or economic stress "would be wise … not to see this as a reflexive buying opportunity," agreed Paras Anand, Singapore-based chief investment officer, Asia-Pacific, with Fidelity International, in a March 4 presentation.

At the end of the day, that effective monetary policy put has had "a greater impact on asset prices than on the economy, (and) investors are starting to question whether the playbook has … stopped working," Mr. Anand said.

The economy could finally be facing a situation where short-term policy steps by governments and central banks will be overwhelmed by the fallout from the coronavirus, he said.

Meanwhile, reaction to the U.S. Federal Reserve's latest move — an emergency 50-basis-point cut on March 3, which lowered the federal funds rate target to between 1% and 1.25% — has been decidedly mixed.

The cut was "premature given the lack of data suggesting a significant drag on the economy" and considerable uncertainty about the coronavirus' potential implications, wrote Roger Aliaga-Diaz, Vanguard Group Inc.'s Malvern, Pa.-based chief economist, Americas, in a commentary.

The Fed moved in response to turbulent financial markets rather than hard data, evidence that points to a "politicization of the U.S. central bank" acting in support of a government that looks on the performance of the S&P 500 almost as a "referendum on the success or health of the presidency," Mr. Anand said.

The Fed's move is a "high-risk bet," which could leave it in a difficult position should a continued deterioration in economic conditions call for further steps to buoy the economy in coming weeks, Mr. Aliaga-Diaz said.

A number of analysts predict U.S. stocks as well as the U.S. dollar could lose some of their uncontested dominance of recent years as investors work through the challenges of the coronavirus outbreak.

For the last decade, investors who assiduously diversified their exposures beyond U.S. equities have been penalized, but "I think it will be different this time," said Paul Sandhu, BNP Paribas Asset Management's Hong Kong-based head of multiasset quant solutions and client advisory.

Emerging market equities, and Chinese stocks in particular, are beginning to attract more investment, and that trend should accelerate as the year progresses, he predicted.

Timothy Graf, London-based managing director and head of macro strategy for Europe, the Middle East and Africa at State Street Global Markets, said with the risk-reward balance for fixed income looking increasingly poor now, "my preferred portfolio construction is to hold equities while raising cash balances, effectively barbelling a portfolio between largely riskless assets and those with the strong potential to recover."

For now, moderating total portfolio risk remains the best approach, Neuberger's Mr. Knutzen said, predicting "there will be better entry points to add risk in equities in the future,"

Mr. Graf agreed. Buying the dip will prove a prudent strategy at some point but the "euphoric melt-up" of equities from late 2019 to early 2020 leaves ample room for further declines, he said. Meanwhile, investors with lingering hopes for a V-shaped recovery this year will likely be disappointed, he added.