Investors are now considering two key questions: what will drive markets in the near term and what will be the longer-term implications of the current crisis for asset allocation?

Phase I: China-focused supply chain shock (20 Jan – 21 Feb)

In Phase I the potential impact from the coronavirus was seen largely in terms of the supply chain disruption of closing Chinese factories. The impact on markets was for commodities, like crude oil and base metals, to sell off. Bonds and gold rallied and, although they briefly dipped in late January, US equities largely shrugged off concerns about the coronavirus. Corporate bonds and the USD also rose.

Phase II: Global demand shock (24 Feb – 6 Mar)

In Phase II investors became more concerned about the global impact on demand after the sudden increase in reported coronavirus cases in Italy. In this period, we saw a typical risk-off response across asset classes to the threat of an economic downturn, with equities and commodities declining but bonds and precious metals rising. Investment grade bonds rose and the USD weakened.

The recovery in risk assets suggests investors are betting that we may see a peak of the crisis in the coming weeks and a re-opening of the global economy. The gradual relaxation of measures which has begun in China and will soon begin in Austria, Denmark and the Czech Republic has raised hopes that other countries will shortly follow their lead. In this upbeat scenario, markets and the global economy experience a V-shaped recovery where most of the economic damage is experienced in Q2 and the global economy shows signs of recovery as we move into Q3.

What are likely to be the longer-term knock-on effects from the crisis that investors need to consider?

Although there is considerable debate amongst economists about the severity of the economic downturn, and the timing of recovery, the consensus is that this is largely a policy-induced recession (economist Paul Krugman has likened it to putting the economy into a temporary coma). Therefore, the economy should be able to bounce back relatively quickly whenever social distancing measures are fully relaxed. That said, we will have witnessed an economic downturn and associated policy response without parallel in modern economic history, so investors need to consider what the longer-term unforeseen consequences of the coronavirus may be.