Some calm after the storm

As a measure of calm is restored in financial markets, Guillermo Felices, head of research and strategy for Multi-Asset and Quantitative Solutions (MAQS), and Dominick Dealto, chief investment officer fixed income, discuss the potential opportunities and risks ahead for investors.

In recent weeks, we have seen major dislocations of financial markets. How do you now monitor the impact of COVID-19?

Guillermo: COVID-19 is first and foremost a public health emergency. It has triggered an economic shutdown in many countries and a policy response from leading central banks that would have been unthinkable only weeks ago. We are closely monitoring the impact of the virus on financial markets via four key pillars:

• the evolution of the virus
• disruption/resumption of economic activity
• policy responses
• measures of market sentiment and stress.

COVID-19 is travelling from East to West. Europe is in the eye of the storm now, with numbers of new infections still rising rapidly, but with some first signs of stabilisation in Italy. Looking westward, the impact of the virus on the US economy is already appearing in data releases. There’s no doubt that economic activity data will be grim everywhere for some time. But in China, activity is gradually rising again. We see this in the data on industrial activity, energy consumption, and to a lesser degree, in consumer spending. Policy responses around the world have been very aggressive, with fiscal policy taking over the baton from monetary policy. Major central banks’ policy rates are effectively at zero and most have aggressively restarted programmes of quantitative easing (QE). On the fiscal front, the US government announced a USD 2 trillion package that includes cash payments to households and help for small businesses. In Europe, fiscal packages are also very large, with most governments offering considerable guarantees to support businesses and consumers. Finally, indicators of market stress have fallen from their highs, but market sentiment is still extremely depressed. On balance, our investment base case is that the impact of COVID-19 on the global economy will be mitigated by the measures the authorities are taking. We anticipate a ‘U-shaped recovery’. The main risk is prolonged and intermittent shutdowns that lead to a longer global recession. Separately, our market temperature indicators are flashing ‘dark green’, typically a good contrarian ‘buy’ signal for risk. And our dynamic technical analysis suggests that commodities-linked assets are attractive in the medium term. This view is underlined by our analysis of the fundamental data.

How have teams been coping with conditions in the bond markets? Where do you now see opportunities for long-term investors?

Dominick: Our fixed-income teams are located in eight different countries on three continents and for the last two weeks, team members have been using the technology available to us to work from home. As a result, we were well organised when the lockdowns began. Equally importantly, our portfolios were well positioned. Before the crisis began, we had reduced risk to reflect our view that growth in developed economies would slow. Of course, we had not reckoned with such an abrupt shock, but we were able to further reduce risk as we rode the storm. With profound changes in monetary and fiscal policy underway, there are now signs that the tide is turning. There has been an indiscriminate sell-off driven by fear as markets integrated extreme outcomes into valuations. It is precisely in this sort of environment that we as an active manager come into our own. Excellent credits are now trading at valuations that reflect indiscriminate selling rather than the fundamental factors that will matter in the longer term. We are applying the rigorous analysis that is inherent to our investment process to identify such opportunities across the different segments of global bond markets For investors seeking opportunities over the long term, I would highlight investment-grade corporate debt and emerging-market hard currency debt as two segments where current valuations offer potentially attractive entry levels.

And what about multi-asset portfolios? How are they now positioned given your analysis of how the situation is likely to develop?

Guillermo: Unfortunately, the number of COVID-19 cases is rising in the US, which has led us to reduce our exposure to US equities to neutral. We have increased our allocations to UK equities as we think the sell-off has gone too far. Our positive assessment on the outlook for global commodities as Asia recovers has led us to overweight the Australian dollar versus the US dollar. Finally, we remain overweight eurozone and emerging-market equities. There are opportunities in these markets that arise only after panic selling. For long-term investors, now is the time to start re-entering some of these markets.

Any views expressed here are those of the speakers 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.