Economic Performance & Outlook
The overarching concern for everyone at the moment – investors, politicians, policymakers – is the fallout from the coronavirus outbreak and how we will mitigate the damage done to the economy, both from the outbreak itself and the necessary steps taken to curtail social activity. As we write, equity markets are down somewhere between 20 and 30 per cent, with volatility remaining at levels last seen in the global financial crisis in 2008, and it is unclear as to when and where they might ultimately settle. The economic uncertainty caused by the virus has hit particularly hard areas such as hospitality and travel, but also dampens activity across vast swathes of our economic model in areas such as consumer spending and the ability of globally-interconnected manufacturing and supply chains to withstand the pressures now upon them.
The crisis has put financial markets under immense strain. The prices for bonds and equities tend to move inversely, with the former favoured during downturns and equities rising in value when people expect more benign conditions. Unusually, over recent weeks, there have been declines for normally robust government bonds and certain safe haven assets such as gold in tandem with stock market tumbles. This appears to have been driven by the fact that many investors were driven to unwind holdings in bonds and gold to cover losses on their stock market investments.
It is impossible to consider the present situation without referring to the economic conditions at the end of 2019 and early 2020. A few weeks back, we were discussing how equities in general had had a very good run and were looking overpriced on a range of different measures. We had been expecting a correction for some time and were underweight in this asset class. The recent declines in equities have increased value in this area and we have moved to a neutral position. This does not discount the potential for further declines in the stock market, rather that it has moved out of the territory of being considerably overvalued. It’s also fair to say that there remain uncertainties in the economic model independent of the virus which we have identified in the past, such as the rise in nationalism and the ongoing trade spat between the US and China.
We have spoken also of historically low levels of interest rates. Rather than any turning point here, this trend has been copper fastened in recent weeks as policymakers have desperately tried to bring some stability to markets by essentially offering lending at near zero rates. The prospect of increased fiscal stimulus from governments looking to kick start an economy cowed by the coronavirus only adds to the uncertain mix and may at some stage precipitate increased inflation which has doggedly stayed low over recent decades.
In conclusion, the coronavirus has been the catalyst that marks an inflection point in the direction of markets. The uncertainty will run as long as the crisis continues, with the effect and outcome in the US, still the world’s largest economy, even harder to measure given the unpredictability of President Trump in his response. We will proceed cautiously, looking for opportunities where declines herald increased value.
Bond performance over past year
All bonds 10+ years, 25/03/2019 – 25/03/2020, local pricing
The German 10-year bond yield, which had climbed out of negative territory last year, is continuing to trade well below zero, showing the demand for Europe’s most highly rated debt. US Treasury yields have also declined and their spread over German Bunds has narrowed.
With such poor returns from bonds, it may at some stage make sense to look further afield for higher yields, such as credit or emerging market debt.
Equity performance over past year
25/03/2019 – 25/03/2020, local pricing
Equities have tumbled in recent weeks as the economic havoc of the coronavirus became evident. However, the generalised decline masks the fact that some areas that have done better than others. The US has outperformed some other markets helped in part by big tech companies who may prosper amid social distancing. With Europe the current epicentre of the coronavirus outbreak, it’s not surprising that local markets have performed poorly. Declines of course produce investment opportunities and we are moving from an underweight to a neutral position. We generally recommend that clients access broad global equity market beta in a low-cost passive manner, but do consider some active management where we see opportunities.
We believe implementing a hedging strategy to be of value, particularly for those who may have benefited up until now from an unhedged position.
Finally, we expect emerging markets to outperform developed markets over the medium term, albeit with increased volatility, and valuations remain attractive. There may be a short-term case to increase this allocation beyond that indicated by world market indices.
European Property
We continue to believe that property shows some potential. While we are cognisant that there are challenges to commercial property that may result from the significant shift to people working from home and shopping online in recent weeks, overall we believe there is a strong long-term outlook for this asset class, and that it should add value within a return-seeking investment strategy.
Commodities
Commodity performance over past year against equities
25/03/2019 – 25/03/2020, US dollars
Commodity markets, dominated by energy and oil, have continued to be volatile in recent weeks, in part spurred by aggressive production by the Saudi government. We believe prospects for commodities remain tempered due to lower demand in commodity-intensive industries and lower growth expectations in China, which had been a significant consumer. In the longer term it is worth considering the significant shift across the globe to a focus on renewable energy and this will be a key consideration in future for commodity and equity investors.
Hedge Funds
Hedge fund performance over past year against equities
25/03/2019 – 25/03/2020, US dollars, hedge funds priced monthly
The absolute performance for hedge funds has been disappointing, however their defensive attributes should come more into focus during the market downturn.
Currency Funds
There have been distinct sharp movements in currencies in recent months, with the coronavirus fallout continuing this theme. These funds will be useful for diversified investments.
Global Tactical Asset Allocation Funds
With a wide range of assets held, these funds should provide improved diversification.
Senior Loans
These vehicles, which invest in floating-rate instruments with a strong covenant, provide a premium over cash in return for illiquidity and credit risk. They also provide diversification. Most of the funds investing in these instruments have experienced sharp falls over recent weeks as they tend to be less liquid than corporate and high yield bonds. Under all but the most extremely negative scenarios they look to be attractively priced and offer the potential for strong risk-adjusted returns from here.
Portfolio Structure & Risk Management
- It is very important that clients have a disciplined management framework for determining how to structure portfolios and how to adjust that dynamically over time.
- Acuvest recommends that portfolios comprise a diversified mix of asset types which balances the desire for high returns with management of the associated risks. For this purpose, we group assets into three categories: growth (including equities and property), managed risk (including global tactical asset allocation funds, certain types of hedge funds and sub-investment-grade credit risk) and defensive (including bonds and cash).
- Within clients’ portfolios, we have been running a high cash position. Given the recent falls in equity markets we have moved from negative to neutral on equities recommending that our clients put some of their cash to work – something we are working with them on to do in a disciplined way.
- In a low-return environment, keeping fees low is particularly important.
