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As markets shift rapidly and the coronavirus disease 2019 (COVID-19) spreads across continents, our portfolio manager Leon Goldfeld shares how he filters out market signals to stay invested.
Investors are facing a relatively eventful time, with an oil price collapse, more rate cuts and uncertainties over the ramifications of COVID-19 on growth and corporate earnings. Against this backdrop, what could fund managers do to filter out market noise and set actionable insights to stay invested?
Leon Goldfeld, a portfolio manager of our Multi-Asset Solutions (MAS) team, relates how he navigates the re-pricing of markets for potential income opportunities, and gives an update of our multi-asset strategy.
With an oil price collapse, the global spread of COVID-19 and more rate cuts dominating headlines, what are the market implications?
These are unique times. For the first quarter and into the second quarter, we’re likely to be in a period of weak global economic growth with a high probability of it being a recession. What we shouldn’t lose sight of is that if the COVID-19 situation is brought under control in the next few months, we do see the likelihood of a very strong bounce back in global economic activity in the second-half of the year - one that is going to be supported by policy actions and will commence from a low base. The recovery in the second-half may not offset the activity that has been lost in the first part of the year but it is likely to be substantial. Read more: Investing during the COVID-19 outbreak: 4 topmost concerns
Q2. WHAT IS YOUR MULTI-ASSET STRATEGY?
The uncertainty over global growth does lead us to take a more conservative stance in asset allocation at the present time (as of March 2020). We have become more cautious in our risk taking and we have increased our exposure to bonds quite meaningfully, in order to get exposure to duration. Bonds provide a good diversification and a partial hedge to the equities positions.
Within equities, we have been underexposed to Europe and Japan which have suffered due to the more economically cyclical nature of the markets. Our relative preference is to the US market as it has higher quality companies and earnings are more resilient. Within emerging markets the preference is for Asian markets. Asian markets have coped with the COVID-19 outbreak for longer and have adjusted more. Asia being a net oil importer also benefits from lower energy prices which also allows more scope for Asian central banks to loosen policy.
Multi-asset investing allows diversification of asset classes, including those with low to negative correlation. The correlation between US Treasury yields1 and the global stock markets is negative - almost at record negative correlation. While negative yields1 in places like Japan and Europe have a weaker correlation to equities, we do still see duration as an important way of managing downside risk in equities, so that’s a key hedging tool2. Read more: The secret to effective diversification
Q3. HOW DO YOU DETERMINE WHETHER THE MARKETS HAVE BOTTOMED?
We have been looking at the market signals from three different angles:
1. COVID-19 and its spread around the world
The outbreak of Severe Acute Respiratory Syndrome (SARS) in 2003 is an interesting case study. During SARS, the bottom of the market coincided with the peak in the escalation of new viral cases. So while the actual number of cases were growing, the rate at which they were growing had started to come down.
If you look at what happened to the China, Hong Kong and Korean markets, they have more or less found bottom around the time that the peak escalation in new cases occurred (mid-February3 to early March4). So for us, one of the key indicators would be when will the acceleration of global new cases actually peak-out.
We’re also looking at how aggressive will containment be for COVID-19 in Europe and the US. The greater the containment the more likely the acceleration is likely to peak out.
2. Economic policy measures and how effective are the actions being taken by the authorities
Another area that we’re looking out for is much more coordinated and aggressive fiscal policy measures. The US administration has begun to discuss a number of fiscal measures to support workers’ income as well as to provide funds if they fall ill. The US Federal Reserve has brought down the federal funds rate to a target range of 0%-0.25% in two emergency rate cuts. The European Central Bank is likely to cut rates and the Reserve Bank of Australia, the Bank of Canada and the Bank of England have cut rates. So we’re having some coordination in monetary policy. For markets to look towards a recovery of economic growth, those policy measures would need to be on a larger and more coordinated scale. The announcements thus far have been helpful but not as yet sufficient.
3. Technical measures and valuations5
If we look at traditional valuations, such as price-to-earning (P/E) measures of markets in the US, Europe, Asia and Hong Kong, there is disparity. The US market doesn’t really look relatively cheap on P/E but Asian markets do. And European markets are beginning to look relatively attractive as well. So valuations are beginning to become interesting although they are not at ‘deeply undervalued’ levels.
If we look at equities against other forms of investments, comparing dividend yields1 to bond yields1 or cash rates, those spreads, or equity risk premiums, are extremely high by historical standards making equities relatively attractive on a relative basis. Valuations do not help to time the market but they do signal that opportunities in equities are building.
It is difficult to be very precise with timing. What we know from previous large market declines is that recoveries build over time and tend to last for a considerable period of time. The combination of attractive valuations, stabilisation in the rate of increase of COVID-19 cases and strong fiscal and monetary stimulus is likely to provide a good base for medium-term investors, based on their investment objectives and risk appetite, to consider increasing their exposure to growth assets. Market sell-downs and panics can create medium-term opportunities for investors. We expect it will be no different this time.
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Uncertainties are here to stay so it is important to filter out market signals and stay invested. A multi-asset income strategy that invests in asset classes with low to negative correlation could help build a diversified portfolio with potential for relatively attractive income opportunities and a balanced risk profile.