Ashwin Alankar, Head of Global Asset Allocation, says the market sell-off has increased illiquidity in financial markets and that a targeted policy response is needed to stave off the potential for small business defaults, which would greatly weigh on economic growth. However, options markets now signal more reward than risk in equities.
- In the current market environment, higher-risk asset classes such as high yield bonds have seen liquidity start to dry up, impacting even normally liquid instruments, such as ETFs.
- Markets are also panicked about potential bankruptcies, particularly among small businesses that rely on a constant flow of customers for revenue – now at risk because of social distancing measures. A significant policy response will be required to support these businesses and forestall a financial crisis.
- With the US 10-year yield now well below 1%, Treasuries may not provide enough of a cushion for equity losses. However, options prices suggest that the risk premium for equities looks attractive. We also believe short-duration bonds could help provide diversification.