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Weekly Newsletter

Week of 13th April 2020

What’s on our mind this week ?

Asian volatility: calm in a crisis

On 16th March the CBOE S&P Volatility (VIX) Index hit a level of 82.69, the highest ever closing level of the Index in its near 30-year history and, aside from the 2008 financial crisis, only second time the Index has exceeded 80. Given the massive swings we have seen in global asset prices in recent weeks, such a spike in volatility is not surprising. Often quoted as the global “fear gauge” the VIX Index is a favourite measure among financial commentators for highlighting the level of risk in the market. Why is volatility important? Because volatility means uncertainty. When it is high it means the market’s ability to estimate where assets will be priced in the near future has broken down, which essentially means more risk. It should therefore not come as a surprise that there is a long run correlation between US corporate bond credit spreads and the level of the VIX.

But what does this index actually tell us about the state of the market in Asia?

Given the US asset prices tend to dominate global financial markets, there has always been a tendency for regional financial risk to take its lead from what is happening in the US. Furthermore, patterns of global capital flows coupled with the high growth nature of emerging markets has historically seen regions such as Asia serve as an amplifiers of financial risk. This was certainly the case of 2008 when a financial crisis centered on the US housing market still saw the Dow Jones Index fall by only 34% (for the year) while Hong Kong’s Hang Seng Index fell by 48% over the same period. For the COVID-19 financial crisis, things do appear to be a little different. Certainly, we have seen massive asset price swings in the US reflected in equities and bonds across the world. However as the charts below are showing, comparing implied volatility measures in Hong Kong (Hang Seng Index) and Korea (KOSPI Index) with the US (S&P Index) and Europe (EUROSTOXX50 Index) shows that Asia volatility has topped out well below US and Europe last month. This is a big contrast to the 2008 crisis when the reverse was true. Figures for China cannot be compared to 2008 due to a lack of data, although Chinese implied volatility last month peaked at 69.24 (on 18th March), well below US and Europe peak levels. This is particularly striking considering China’s implied volatility has, for the past 5 years, averaged 8.8pts and 5.4pts above the US and Europe respectively. 

In other words, Asian markets are simply not fulfilling their typical role as risk amplifiers during the COVID-19 crisis. On the contrary, they are almost acting as safe havens with the Shenzhen Composite index showing positive returns for the year (as of the time of writing). Bond markets’ relative performances between Asia and the US have clearly become distorted by the Fed’s unprecedented move to virtually backstop the entire corporate bond market. However price swings even in investment grade corporate credit have been significantly greater in the US than they have been in Asia in recent weeks. 

What exactly is causing this lower volatility in Asia is uncertain and likely due to a range of factors including Asia’s successful containment of the outbreak so far. Asian investors are showing a greater resilience in accepting this crisis having been through the SARS experience of 2003. Furthermore Asian asset price valuations were more rational going into 2020. Whatever the cause, the Asian markets response to the COVID crisis alongside more measured fiscal and monetary responses by Asian central banks and governments points to a market that has matured and that is increasingly worthy of losing its “emerging markets” moniker. 

Source: Bloomberg  (Hong Kong = VHSI Index, Korea = VKOSPI Index, Europe = V2X Index, US = VIX Index)

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India and Covid-19

India reported its first covid positive case on 30th January. As on 14th April, India’s Covid-19 count stands at ~10,500 infections and 360 casualties. The growth rate of infection in India so far appears to be low compared to the rest of the world. India’s statistics appears even more startling considering India’s population density and poor hygiene conditions. Some experts opine that India has not conducted adequate tests and that the true number of infections could be much higher which can be said for other countries as well. On 12th March when India had 62 infected cases with no casualties, it suspended all existing visas for outsiders in addition to suspending visa free travel for Overseas Citizen of India (OCI) card holders who are generally treated on par with Indian nationals except for the voting rights. Additionally, on the same day India also issued a travel advisory imposing a 14-day quarantine on any visitor arrivals.

We believe India is dealing the Covid-19 issue with caution and has been reasonably early in announcing a country-wide lock down that has helped it to contain the spread of the contagion. On 22nd March  India observed a 14-hour voluntary public curfew followed by a nationwide lockdown for 21 days which started on 24th March and is supposed to end on 14th April 2020. The prime minister Modi while addressing the nation on Tuesday 14th April, the original deadline for the 21-day lockdown, extended the national wide lock down until 3rd May. This came at the behest of several state chief ministers approaching the Prime minister requesting him for an extended lockdown to contain the spread of the virus. The Prime minister in his speech acknowledged that India has paid a big price from an economic standpoint but said people’s lives are far more valuable.

Lockdown of this nature for 1.3 billion people imposes a herculean challenge for a developing country like India where a sizeable portion of the population lives below the poverty line. However, the government has been doing a reasonable job of making the basic supplies available for the downtrodden at low or no cost through the public distribution centers. Even before the pandemic, the Indian economy has been reeling under pressure of financial meltdown and slowing economic growth. The National Restaurants Association, which said its members employed seven million people, warned that there could be “social unrest” if it did not receive financial relief. The commerce ministry is said to have urged the government to consider opening more activities “with reasonable safeguards” even if the lockdown is extended. While the extended lockdown is appropriate from a health care perspective, how the Indian government balances its act with an economy that remains under further reinforced pressure amidst the Covid-19 outbreak remains to be seen.  

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