Investment research firm MSCI upped market assumptions to reflect a more depression-like outcome one month after SARS-like comparisons proved insufficient.

In mid-February, MSCI was using historical data from the 2003 SARS outbreak as a reference for analytics-based stress testing, especially due to the relative concentration of cases in the Greater China region. But one month onwards, the assumptions have proven insufficient and MSCI is now drawing observations from bleaker historical periods. 

«[T]here isn’t something that happened in recent history we can use for reference,» said Jeffrey Ho, MSCI’s head of Greater China consultants in a media call, adding that it now using asset class movements in 2008 as an anchor for predictions.

«The reason we are doing that is that even though this a virus outbreak, [investors increasingly believe] it might turn into something closer to a depression.»

Credit Shocks

Under the revised stress test model, MSCI predicts that investment grade and high yield spreads will spike 60 and 200 basis points, respectively, alongside a 90 basis point drop for 10-year Treasuries. 

But it notes that the current assumptions may still not sufficiently capture the tail risks involved. For example, the model's -22 percent projection for MSCI U.S.A. has already been exceeded and MSCI’s analytics team is already actively adjusting for worse assumptions. 

60/40 Still Intact

MSCI also highlighted the continued effectiveness of traditional «60/40» (60 percent bonds and 40 percent stocks) portfolios driven by a still intact assumption of a negative correlation between the two asset classes. According to historical data, the average correlation on the days that the negative relationship is demonstrated is -70 percent and MSCI’s Ho noted that the market has observed much higher rates in the last two weeks.

This is especially critical for wealth and asset managers globally which rely heavily on this theoretical assumption to manage risk and generate returns for client portfolios. 

«This is important because the negative correlation between bond and equities is the cornerstone for risk parity portfolios and also asset allocation in general,» Ho explained.