Mid-Year Investment Outlook
Message from our Global CIO
Welcome to our mid-year outlook for 2020 – six months that surely rank as the most extraordinary of our careers. Indeed, it is hard to put the enormity of what we have just been through into context. A global pandemic, economies collapsing faster than during the Great Depression, higher volatility in some markets than ever before – and all of this while many of us were confined to home.
Nevertheless, amidst the bankruptcies and soaring unemployment there is plenty to be hopeful about. Governments and policy makers responded at pace. Financial markets stayed open and showed resilience. Lessons from the 2008 crisis were applied. Most importantly, in our opinion, although covid-19 has upended the world, it is also proving an accelerator of existing trends.
The latter is one of the main themes in this report. Trends that were accelerated by the pandemic include a steepening trade-off between risk and return, the use of technology, a focus on sustainability (see the Responsible Investing section for a special interview with our Global Head of Responsible Investment), resilient Asia, low inflation and workforce flexibility.
These long-run developments impact all asset classes and together with the market reaction to the crisis, have given rise to a range of investment opportunities. The key is to be selective and specific, understanding how the risk and reward differs by company, sector and geography. And in this mid-year outlook, our investment heads describe what covid-19 means for the major asset classes and give their outlook for the rest of 2020 and beyond.
Global Chief Investment Officer, HSBC Global Asset Management
The pandemic and lockdown brought the world economy to a sudden stop in the first half of 2020. Despite a rapid policy response, global growth collapsed. Meanwhile, the fastest bear market ever gave way to one of the steepest rallies. We do not fully agree that prices have a disconnect with fundamentals, however.
In principle, macro systems can rebound quicky from self-enforced closures. A V-shape is possible. But our baseline is for a swoosh-shaped recovery. This assumes a ramp-up of testing and tracing, only isolated further outbreaks, and a vaccine available in the middle of 2021.
There are many downside risks: a second wave of infections, solvency and debt problems, or policy support ending too soon. Economies may suffer permanent damage. We put a 60 per cent probability on our swoosh outcome. The best positioned economies belong to China and industrialised Asia. Less resilient are emerging markets ex-Asia, smaller oil exporters, frontier nations and the eurozone.
Strategy wise, the pandemic has accentuated the already steep trade-off between risk and returns. The diversification properties of government bonds are set to deteriorate as macro policy shifts from rate cuts and quantitative easing toward more targeted measures. Therefore, investors need to think harder about how they diversify. Alternatives – liquid and illiquid – should play a greater role.
covid-19 is accelerating trends already in play before the crisis. Some, such as increased take-up of technology and sustainabilility issues are positive for long-run returns. Others are less so, such as the retreat of globalisation and rise of economic populism.
Q&A with Melissa McDonald
Global Head of Responsible Investing
Has the pandemic pushed sustainability down the agenda?
The indication so far is no. The European Union, for example, is pushing ahead with the New Green Deal. Governments are talking about using this opportunity to accelerate the transition to a low carbon economy – increasing investment into renewable energy and building out infrastructure in terms of green buildings, different fuel sources, the transition to the electrification of cars and so on.
This makes sense. The magnitude of the economic and societal impacts from the global pandemic will affect how we live our lives and do business for years to come. For our clients also, the pandemic only further elevates the importance of evaluating sustainable investment considerations as part of any investment discussion.
I would like to see the next phase of government support for businesses conditional on certain sustainability criteria. Likewise, investors could say to companies and governments that human capital, workforce and infrastructure resiliency are all key to the deployment of capital.
Rather than down the agenda, we have seen social issues in particular come to the fore during the pandemic. People of lower socio-economic status have been impacted more, for example. HSBC is working together with industry peers to encourage companies to take social considerations even more seriously.
Mid-year Investment Outlook
Q&A with Joe Little
Global Chief Strategist
We are in the midst of a recession of historic proportions – how did we get to this point?
The global pandemic and lockdown are extraordinary by any measure. What began as regional shock to supply chains evolved quickly into a brutal collapse in global demand. Confidence, consumer spending and the corporate sector retrenched aggressively. Measures to flatten the epidemiological curve deepend the recession curve, which, according to the International Monetary Fund (IMF), has caused the biggest economic crisis since the Great Depression.
In response, policy makers have been bold and rapid. Measures have varied country-to-country, but include: interest rate cuts, purchases of financial assets, liquidity injections, targeted lending for banks and businesses, as well as direct fiscal stimulus, loans and guarantees, and regulatory measures. We have also seen countries coordinate monetary and fiscal policies, representing a dramatic shift to the post-2010 orthodoxy.
Today, our global Nowcast model, which tracks output in real-time, suggests that global growth is running at a minus double digit annual rate, with China and industrial Asia faring better. The world economy came to a sudden stop – as if electricity to the system had been turned off.
This in turn caused a surge in risk aversion in financial markets. Global equities fell by a third in just over a month – the fastest bear market on record. Credit spreads widened by hundreds of basis points and haven assets such as the dollar and treasuries strengthened. Liquidity in many areas of the financial markets dried up.
Subsequent economic and market shockwaves are too numerous to list in full. Oil prices in the red, companies collapsing, millions of workers furloughed, and vulnerable emerging markets hit with collapsing trade, tourism, remittances, and capital flight. The abrupt contraction in credit conditions risked compromising the entire economic system, forcing central banks to act.
Since the middle of March financial markets began to stabilise, and then rally. The extent of the rebound has varied across asset classes and regions – the US and Asia faring better, for example, while emerging markets lag. However, it is hard to over-state the damage that has been done to the global economy. It has been a truly remarkable first half of the year.
Global CIO Multi-Asset
While the sell-off in March was typical in that riskier assets led the declines, the subsequent rally was not. It has been relatively defensive. Even within risky assets, safer ones have outperformed.
The massive monetary and fiscal action has reduced tail risk and markets are suggesting an event-driven bear market, which does not morph into a cyclical one. Long-term investors can afford to be a bit more relaxed. For those with a shorter-term horizon, however, there are still some cyclical risks and it may be opportune to take some risk off the table after the rally since March.
Our approach is to build risk-on/risk-off portfolios that can perform well in different scenarios. We are neutral on equities, balancing cyclical markets such as Brazil with defensive ones such as the US and developed Asia. In fixed income we favour assets supported by central banks. We are overweight credit and investment grade bonds while cautious on emerging market bonds.
Exposure to government bonds has been reduced. They are unattractive from a valuation perspective and their hedging properties are not helped by near-zero interest rates. We believe alternatives can be more useful here, while diversifying via other defensive assets, including gold and currencies such as the dollar, Swiss franc and yen.
Selection by sector and geography is key, while specific asset classes are cheap versus history. Examples include Canadian, Australian, Polish and Brazilian equities. Likewise, the Norwegian krona and Mexican peso sit at historically low valuations right now. US breakeven inflation rates are also compelling.
Global equities outlook
Global CIO Equities, CIO Asia Pacific
Equity investors experienced a one third drop in dollar terms across developed and emerging stock markets by mid-March. The recovery has been uneven, however. Many US technology and onshore Chinese shares have raced ahead – accelerating pre-crisis themes. Meanwhile, many emerging markets are still reeling.
What do current valuations reflect? Analysts have roughly halved their earnings forecasts for 2020 and do not expect a recovery to pre-covid-19 levels for four years. This is too bearish. We assume a one third cut in earnings in developed and Latin American markets this year, with emerging Asia down a fifth and China just six per cent. Our equity model suggests the return from equities over and above risk free assets remains compelling. We prefer Asia, with a focus on China, South Korea, Taiwan and Hong Kong. They are attractively valued, have a lower exposure to commodities and oil, and have shown to be better equipped to cope with the covid-19 crisis.
Similarly, a number of e-commerce companies have shown resilient business models. And selective healthcare names will benefit from post-covid spending. We also have seen the rift between defensive and value stocks widen dramatically, with the former looking even more expensive and the latter trading at historic lows.
Global fixed income outlook
Global CIO Fixed Income, Private Debt and Alternatives
Covid-19 is also reinforcing trends that were already forming in fixed income, such as low inflation connected to workforce vulnerability, secular deleveraging, a dispersion in the level of central bank support between countries, and an acceleration in sustainability. Some trends will reverse. A wave of defaults and downgrades will tighten credit and squeeze balance sheets. We do not expect the demand for oil to rebound to previous levels.
Another key driver will be a renewed ‘low for long’ theme in developed market interest rates. We expect there to be more yield curve control by central banks, in order to lower public debt to GDP ratios. We anticipate very directional curves, with a flattening bias. Tactical opportunities may arise in the euro periphery.
In credit, we expect some bifurcation within developed markets, with a split between companies that are in or out of scope of central bank programmes. The high yield market will bifurcate the most. Regionally, we see relative value in Asia, where yields have increased and the region has proved more effective in coping with the pandemic, alongside a rapid monetary and fiscal response.
Credit selection remains crucial given divergent paths of companies and industries. There is also a country dimension, with higher risks in frontier markets that are more exposed to the turmoil in commodities and global trade. Our high-yield preference is the US over Europe. For leveraged loans, higher risk and illiquity premiums have increased their relative attractiveness, even if further downgrades lie ahead.
Global alternatives outlook
Global CIO Fixed Income, Private Debt and Alternatives
Listed property suffered steep declines in March, while unlisted property was helped by the fact that values are not live. We feel the listed property sell-off was an overreaction. Dividend yields have risen dramatically, exceeding six per cent at one point in March. For direct property, however, we expect further price declines. As with other asset classes, the pandemic is accelerating familiar themes – for example the reduction in face-to-face retail and value of logistics properties. While the immediate impact on office demand may be negative, we do expect high quality, well-located spaces to retain their value.
Hedge funds showed resilience through the first quarter, with an average decline of around seven per cent. This compares favourably to most other asset classes. Within hedge funds, relative value strategies struggled as did long/short equity strategies. Notably, there were various hedge fund segments that were able to preserve capital through the crisis. Regardless of which economic rebound scenario comes to fruition, we believe hedge funds can continue to deliver the consistent returns they have demonstrated recently due to a diversity in sources of returns.
Private markets have seen a hit to valuations, but dealmakers learned from the financial crisis, limiting their exposure to cyclical companies and employing less debt. Furthermore, managers have been proactive, boosting liquidity to strengthen their positions or to use opportunistically. Deal activity is down, as are distributions. However, it is a postive environment for new money. Recent vintages still have most of their capital to call and substantial cash to invest.
In high yield, depressed values may have strayed from fundamentals, particularly for infrastructure assets with steady cash flows. Within investment grade, some assets are suffering from credit stresses, particularly those exposed to vulnerable sectors such as travel. However, investment grade has broadly remained resilient and fairly priced in our view. Most infrastructure debt projects are typically decoupled from economic cycles. Transport, however, is one sector where we will see cashflows impacted by the speed of recoveries. Infrastructure debt remains attractive, offering excess yield over corporate investment grade credit, with assets that are also more defensive.
Global liquidity outlook
Global CIO Liquidity, CIO USA
The first half saw a global liquidity event in money markets. There was a sharp widening of the spread between three-month Libor and the overnight swap rate, a metric many investors monitor. While spreads have since narrowed, stresses remain. The differing actions taken by major central banks have had an impact on how money markets have behaved.
Our response has been to build short-term liquidity in our funds by increasing the amount of assets maturing overnight and within one week. The crisis has also shown our concentration policies to be effective tools in managing liquity risk. A five per cent maximum rule for individual clients proved its worth, while we learned from previous crises which clients are more prone to redeem.
Credit risk and the preservation of capital is just as important to money market investors. Therefore, another focus is minimising the risk of credit rating migration below the minimum rating level required, which could force us to become sellers. We cannot ignore market risk either, given the spectre of ultra-low (and in more cases, negative) interest rates for the foreseeable future.
Asia Mid-Year Investment Outlook 2020
CIO Asia Pacific