In focus with Joanna

A message from our CIO

24 April 2020

Last month, as volatility in markets rose to levels not seen since the financial crisis, I wrote to you to explain the measures we were taking across our business to ensure your investments were as resilient as possible. It was a challenging few weeks as markets became very difficult. Some trades that would normally have taken our dealers a matter of minutes were in many cases taking hours.

At the same time, all of us – our clients included – were adapting to new ways of working under lockdown. Nerves were on edge. The number of coronavirus cases was growing in Europe, the curve in America was steepening daily, and no one knew whether Asian style containment measures would be effective around the globe.

Yet our message to you in mid-March was to stay invested. This view was based on the three things we did know. Asset prices had already fallen precipitously. Second, the world’s governments and central banks were pulling on every fiscal and monetary lever available. And finally there was a glimmer of hope as early-suffering China began allowing people back to work.

Although we are in no sense back to normal, the immediate shock has now passed. Since then, the expected volatility of the S&P 500 has halved, global equities are up a fifth, and high-yield credit markets have regained more than a third of their losses. The rebound has been as rapid as the sell-off. This in itself underlines the risk in churning portfolios when markets are turbulent.

Understandably investors remain jittery. But with room to breathe at last, the question is what to do next. Have we just seen a classic bear market bounce, or should we be adding to risk assets now that a growing number of countries are getting ready for a cautious Covexit? It is a hard question to answer with any certainty when even policy makers cannot predict the pandemic’s future course - but let me share my thoughts.

There is no consensus. One side of the argument runs that as lockdowns are eased, pent up demand is unleashed, consumption and capex will surge, cash begins to flow and credit conditions ease. Companies spring back to life. The global economy, which was strong before the crisis, will benefit from lower input costs and interest rates. Some optimists even hope the shock has made workers more flexible, digitally savvy and productive.

The bearish counter-argument is no less extreme. Confirmed cases have pushed through 2.5m worldwide, with no vaccine in sight. Global growth has collapsed and more than a billion people are employed in sectors facing a severe decline in output, according to the International Labour Organisation. Companies are straining with debt and now government balance sheets have blown out too.

With such contrasting outlooks, it is useful to take a step back and look at what is already discounted in asset prices. That is a baseline against which investors can then ponder different scenarios. For example, our calculations suggest that global equities have already priced in a halving of earnings this year, followed by a gradual recovery (25 per cent per annum) over the next three years.

Our own view is that this is too negative a path for earnings, hence our constructive long term position in Equities. You may have a different opinion, but at least an approach such as this helps to frame the debate. Likewise, the stock of sovereign bonds with yields of less than one per cent has doubled since January and now stands at 80 per cent of bonds outstanding. Does that make sense? We think not, and therefore maintain our mildly negative view on treasuries and bunds for this year.

Stress-testing what markets are pricing in is also helpful for real estate. We believe listed sector dividends, for example, will drop sharply over the next 12 months – particularly for leisure, entertainment and parts of the retail market. We assume growth picks up thereafter, but have pencilled in double-digit cumulative declines in dividends over the next five years. Despite this cautious outlook, current yields imply long run returns of between six and seven per cent.

All forecasts for this year venture into the unknown. A vaccine or drug therapy may be successfully put into production – equally those emerging from lockdown may run into a second wave of infections. Even if the global economy recovers, the permanent impact on long-run growth will not be fully understood for years – much like after the financial crisis. That said, a very negative outlook is already priced into many asset classes and the differential experience of companies, sectors and countries will justify widely different valuations as we emerge from this crisis. Value is there to be found for clients willing to look towards the long term.

Best wishes

Joanna Munro
Global Chief Investment Officer
HSBC Global Asset Management