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Positioning your portfolio for the risks and opportunities ahead
Source: International Adviser Publication
Four themes driving investment markets over the next 12 months: recession, low oil prices and yields, stimulus, recovery, and active edge.
For each of these themes, there are seen as three key investment ideas. The coronavirus outbreak prompted the fastest-ever bear market as the MSCI All Country World Index plummeted 33.6% from February 20 until March 23. Then, after stimulus was announced, the index rallied 27.8% to the end of April despite deteriorating economic data.. Investors now face some difficult questions. Is the recent stock market recovery sustainable, or is it merely a bear-market rally? Which investments are the likely winners and losers as the global economy recovers? And how should portfolios be positioned given there is so much uncertainty about the future? Our themes are based on how we believe the global economy will perform over time and the investment implications arising from that. For each theme, we offer three investment ideas. 1. Recession The global economy is expected to severely contract in the first half of 2020 at a magnitude not seen since the Great Depression in the 1930s, then either sharply expand in the second half of the year or recover more gradually into 2021. It is challenging to make money in recessions. Although money‑printing quantitative easing could be inflationary, inflation is unlikely to rise in the short term, not only because of the recession, but also because secular forces including low energy prices, demographics, and technology keep it low. Central banks have been struggling to lift inflation to meet their targets. Investment Theme No. 1: Recession
Some sectors are likely to continue to be winners. If the recovery stalls and lockdowns and social distancing remain in place for a longer period, technology may benefit, allowing for remote connectivity, online shopping, and cloud computing. This is on top of ongoing technology‑led disruption, where investors should be on the side of the disruptors, not the disrupted. If the coronavirus makes a comeback after the summer before a vaccine is developed, health care will remain critical.2.
2. Low Oil Prices and Yields
Overshadowed by the coronavirus crisis, the other drama in 2020 has been the fall in the price of oil. The challenge with oil is not just the fall in demand—when was the last time you filled your car with fuel?—but also oversupply. A low price of oil typically means low inflation.
Bond yields are low and are likely to remain so for the next 12 months. Low yields make it harder for banks to make a profit. Growth stocks in the U.S. may continue to outperform value stocks because 40% of the Russell 1000 Growth Index is technology while 20% of the Russell 1000 Value Index is financials and 5% is energy (0% in the Russell 1000 Growth Index).2 Low oil prices and low yields mean there will be some losers and some winners.
Investment Theme No. 2: Low Oil Prices and Yields
The unprecedented amount of stimulus injected into the global economy over the past few months has offered a lifeline for individuals, businesses, and economies. While policymakers may have kicked the can down the road, leaving themselves with a mountain of public debt and possibly inflation to deal with another day, the situation would have been much worse without the stimulus they provided.
Investment Theme No. 3: Stimulus
Policymakers are all in—they are unlikely to be able to reverse their policies until the economy finds a strong footing. These policies have created both challenges and opportunities for investors. The three investment ideas here focus on (1) yield scarcity—when cash and government bonds yield close to nothing, (2) piggybacking central banks—buy what they buy, and (3) risk assets—in a flood, everything floats.
Crises typically go through three phases: meltdown, bear-market rally, and recovery. The meltdown is behind us. However, it is unclear whether the rebound of risk assets from their March lows is a dead cat bounce, meaning markets are likely to go through periods of significant ups and downs, or a sustainable recovery.
Investment Theme No. 4: Recovery
For the recovery to be sustainable, markets needed three things: (1) the peak infection rate to have passed, (2) a convincing and aggressive monetary and fiscal stimulus, and (3) receding volatility. Although all three are in place, many unknowns linger: a risk of a second wave of infections, the ability of a scarred economy to recover, and the pace of returning to a new version of normality. One scenario is for a steep and strong economic recovery in the second half of 2020; another is for a gradual recovery into 2021. One thing is sure: The crisis will end, and a recovery will begin.
The three investment ideas here are (1) diversification—true diversification, not perceived diversification, as some assets (e.g., corporate bonds, commodities) might exhibit low correlation with equities in good times but high correlation in bad times; (2) balancing offense and defense; and (3) flexibility—portfolios must be nimble, ready to adjust.
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