Covid-19 is a classic black swan event. It was unpredictable. It was completely underestimated at the start. And it will be easier to analyse in hindsight. But when we reach the point of hindsight is extremely difficult to predict.

We have witnessed significant trauma in financial markets as they struggle to compute the impact of Covid-19 on the global economy. While the scale and speed of market slumps have been severe, there are parallels in history. The most important thing to remember is that markets recovered.

Investors now face critical tactical and strategic decisions, and they need to take a view on two competing narratives:

  • Covid-19 is broadly manageable and will have at most a medium-term negative effect after which the global economy and financial markets will recover and “normalise”, albeit with important lessons learnt, or
  • Covid-19 is a “game-changer” that will profoundly transform all aspects of economic activity, financial markets and society in ways we have yet to fully comprehend.

High volatility that characterised financial markets recently will persist until clearer evidence emerges to support one narrative or the other. And the speed of the fall or recovery will be rapid.

All risk assets have fallen sharply in value, with betas racing to 1 (one) as investors have sought liquidity and safe havens. Passives have reinforced indiscriminate selling across and within asset classes.

The high levels of volatility have made markets look disorderly, but they are actually behaving rationally in response to the news flow, which has been so unpredictable. Extreme volatility will continue until an equilibrium consistent with a less clear future emerges.

We also know financial market leverage is less than before the global financial crisis (GFC), but still material and increasing. We don’t expect systemic risk now, given the abundant liquidity being made available to the system.

Fiscal and monetary policies, while initially slow, are picking up pace sharply, but they can only soften, not reverse, severe economic conditions ahead. They are also finite in time and resources.

We think the global economy will experience a sharp contraction ranging from six to 18 months and on a scale comparable to the GFC and World War 2. As a result, no business will be immune to a sizeable deterioration in earnings and profitability. Even with government support, countless businesses will fail and unemployment will rise sharply.

We don’t know what has the market already discounted. For example, how much of the narrative that “it will get worse before it gets better” is already in the price of assets.

The effect of the current and possibly future containment policies on economic activity across the globe is another unknown, as is the knock-on effect of slower economic growth on earnings, profitability and pricing for all financial assets.

We don’t know what the magnitude of corporate bankruptcies will be and the blowback to the real economy, financial markets, unemployment and consumer spending. And we also don't know what, in response, the size and effectiveness of government bailouts will be, how deficits will be funded or written off, the degree of state involvement in the global economy, the effect on inflation and so on

Key questions investors need to ask themselves:

Can I take on more risk? The answer to this depends primarily on your time horizon, as well as your income and liquidity requirements. If you were already beyond your risk budget before the Covid-19 crisis, you cannot afford to take on more risk.

Should I sell across the board and re-enter the market later? This is tempting, but how are you going to time the market better than everyone else in the market? We all know this one is one of the riskiest moves in investing. The best advice is that unless you really need the cash, now is the time to sit tight.

Should I sell assets that haven’t fallen yet as much as the broader market?  If those assets have held up, they have probably done so for good reasons, and they are likely to continue holding up.

Should I maintain my overall risk exposure, but modify the mix?  You could consider rotating equities from best to worst, switching from growth to value shares, and moving from developed to emerging markets. But for most investors, the best approach is to let this happen at the fund level, with the fund manager guiding the movements, rather than at a portfolio level.

• Wainer is CEO and head of investments at Stonehage Fleming Investment Management in the UK.

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