Following a week that saw unprecedented central bank interventions in financial markets, Richard Barwell, global head of macroeconomic research, and Denis Panel, chief investment officer for multi-asset and quantitative solutions (MAQS) assess the state of markets and the outlook.
Denis Panel summarises our asset allocation views and Richard Barwell dicusses the factors that, we believe, investors should consider over the coming weeks.
How do you see the situation after the events of the last week? What is your assessment of the outlook?
Richard: The coronavirus will administer a severe and sustained shock to the global economy. Unfortunately, it looks as if the public health emergency will get worse before it gets better. In the last 24 hours, we have seen the governments in India and Australia introduce measures to isolate their populations and shut down the principal sectors or their economies. There is no doubt we are dealing with an unprecedented global health emergency.
Inevitably, there’s considerable uncertainty around exactly how the public health crisis will evolve. It’s difficult to determine either how serious it will be from a human point of view and how long the economic disruption will last.
However, we do think the unprecedented policy response we saw last week from central banks will help to turn the tide in financial markets.
What we saw last week appears, to us, to be a ‘whatever-it-takes’ mentality among central banks in terms of their willingness to socialise the economic cost of the virus.
We have been struck by how quickly policymakers have responded with, in some cases, radical solutions being envisaged. For example, we already have the prospect of central banks financing the deficits that will result from state-sponsored economic support measures.
In Europe, we may well see moves to issue joint eurozone bonds and then channel the funds to the countries most in need of funding.
These are radical policy measures that, in our view, suggest policymakers are shaping up to meet the size of the challenge.
From an investment standpoint, we now think there are opportunities for long-term investors to gradually buy assets that have experienced significant price falls as markets abruptly priced extreme outcomes. Indeed, the extent and scale of last week’s selloff leads us to be fundamentally constructive on the outlook for risky assets.
How have your investment teams been reacting to events of the last few days?
Denis: Our teams are organised across different locations using video conferencing to coordinate and manage our clients’ assets during this exceptional situation. The teams have an intense focus on risk management, but we remain alert to the opportunities that can arise in a volatile environment.
Our approach is being guided by the following principles:
- We expect a global U-shaped economic recovery to be underway by the end of 2020.
- China will lead the economic recovery providing a positive momentum across Asia generally.
- Market dynamics indicators: The metrics we use to assess the balance of risks in markets are flashing ‘dark green’. This is typically a good contrarian ‘buy’ signal for risk.
- We have seen an aggressive response from policymakers, but markets remain volatile. We are preparing to react quickly in our asset allocation and be nimble enough to take advantage of opportunities.
So how are these views expressed in your asset allocation?
Denis: We are positioning portfolios to be broadly in line with the following strategies:
- Equities: Relative to our benchmarks, we are overweight US, EMU and EM equities. As I have explained, we are open to opportunities to increase these overweights while at the same time looking to be nimble and reactive in taking profits. We hold call spread options for flexible portfolios.
- Carry trades: We are overweight emerging market US dollar denominated debt and eurozone real estate investment trusts (REITs).
- Interest rates: We are underweight government bonds in Germany and the Netherlands, overweight US breakeven inflation, underweight US Treasuries via options and we have a position anticipating a steepening of the US Treasury yield curve.
- Overweight gold: We see gold as an attractive diversifier. It offers protection as central bank actions debase major currencies, and a potential hedge in our risk scenarios.
The active risk in our portfolios is currently around 50% of our target, so we have only marginally increased our equity overweight exposures in an environment of higher volatility.
What factors do you think investors should be taking into account over the coming weeks?
Richard: Our view is that there are four elements investors should take into account in their assessment of the crisis:
- How the coronavirus health crisis develops and the length of lockdowns: Controlling the spread of COVID-19 is one of the key elements needed to circuit-break the volatility in markets. News of a vaccine or cure would be a game changer. Otherwise, we need to monitor closely the evolution of the virus and the measures taken to contain it.
- Macroeconomic disruption and business resumption: We know that the economic damage associated with the virus is going to be very significant. Macroeconomic forecasting is very difficult given the uncertainty around how long the crisis will last. However, there is a lot to learn from the early signs of recovery and notably from the business resumption efforts in China and Asia more broadly. It is highly likely that the global economy will be in recession for most of 2020. Our base case is for a gradual recovery towards the end of the year in what we see as a ‘U-shaped’ recovery.
- Responses from policymakers: In any crisis, policy responses are a way of circuit-breaking markets in turmoil. Here we focus on economic policy rather than public health measures. Policymakers have relied heavily on monetary policy since the Great Financial Crisis, so scope for conventional measures from central banks is limited. Fiscal policy is crucial as it can be deployed quickly to support demand and in a targeted way that helps the companies and sectors most in need. After a hesitant start, the latest fiscal measures envisaged by governments suggest to us that they are prepared to match the scale of the challenge.
- Sentiment and systemic stress in financial markets: Investors should also monitor sentiment and market stress metrics to gauge conditions in financial markets. Preventing a health emergency and economic crisis spiralling into a financial crisis is key. Our view is that policymakers have this base covered.
In sum, we are fundamentally constructive about the outlook for financial markets, although we expect markets to remain volatile until there is more visibility on the development of the public health crisis.
Our view is that policymakers will meet the challenge the crisis poses and they can turn the tide in financial markets.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.