Pain and panic, yet this too shall pass
Below is a commentary I wrote that was published by The Straits Times here.
The coronavirus pandemic is wreaking havoc on global financial markets and daily lives, but the world is fighting back.
Countries are enacting containment measures to thwart the virus spread, and policymakers are unlocking incredible sums of cash and credit to keep businesses and households afloat.
The Singapore Government has announced measures worth a whopping 11 per cent of gross domestic product, while the United States Congress has passed a historic US$2 trillion (S$2.9 trillion) relief Bill to aid the ailing private sector and struggling households.
Major central banks globally have unleashed quantitative easing. Leading the charge is the US Federal Reserve, which is buying corporate bonds for the first time ever, and has promised "unlimited support".
This balancing act between restrictions to put the global economy in a coma and historic stimulus to keep businesses afloat has sent the equity market on a roller-coaster ride like no other.
The S&P 500 plunged - in the fastest bear market ever - by a third in six weeks from its all-time high on Feb 19, only to rally 17 per cent in a matter of days late last month.
As companies scramble for cash, a global stampede for US dollars has ensued, sending corporate bond markets and safe havens - such as gold and US Treasuries - reeling. At its climax in the middle of last month, spreads of Asian and US high yield bonds traded to wides of over 1,000 basis points as default fears mounted.
For investors, the key question is whether a bottom has formed and if beaten-down share prices offer buying opportunities.
Relative calm has since been restored - spreads have tightened and US Treasuries have risen - thanks to rapid and expansive actions by the Fed, such as dollar swap lines with 14 global central banks, including the Monetary Authority of Singapore, and facilities to allow for the exchange of US Treasuries for cash.
Still, the economic distress is far from over. For investors, the key question is whether a bottom has formed and if beaten-down share prices offer buying opportunities.
FEAR OF THE UNKNOWN
How risk assets perform from here depends on two factors: the duration of the global shutdown, and the effectiveness of policies to contain its damage.
There are three general ways that the situation could pan out.
- In the best-case scenario, the coronavirus outbreak peaks within the next two weeks, allowing social distancing measures to be substantially eased by the middle of the year. The policy bazooka means no lasting damage is done to businesses, the global economy has a V-shaped rebound and the S&P 500 trades to its fair value of 2,900 or beyond by the year end.
- In the worst-case scenario, the pandemic persists, prompting most restrictions to remain throughout the year. The global economy would have an L-shaped recovery, and the S&P 500 could fall below its fair value of 2,100 to 1,800.
- In the central-case scenario, the outbreak peaks at the end of this month, with the most severe restrictions lifted by the middle of next month and softer measures staying in place for another three or four months. Policy stimulus cushions the worst of the impact, but business closures and layoffs are inevitable. The global economy sees a U-shaped rebound stretching over the third quarter of this year to the first quarter of next year, and the S&P ends this year higher, around 2,650.
The good news is that the work resumption rate is now nearly back to normal in China, and early signs point to some flattening of the epidemic curve in Europe. The bad news is that the US is lagging, and its labour market is falling off a cliff.
HOW SHOULD INVESTORS RESPOND?
Risk assets will stay volatile. A retest of recent lows cannot be ruled out if the epidemic curve fails to flatten, yet a market rebound when it comes could be violent due to the unprecedented stimulus now in play. Investors could position in various ways in today's environment:
Take advantage of higher volatility
- Buying in a bear market allows longer-term investors to put excess cash to work at discounted prices. One way to build up positions is to combine an averaging-in strategy with put writing. The first strategy enables investors to deploy capital while smoothing near-term bumps; the second provides an additional yield while pre-committing to investing if markets drop further.
Cushion portfolios against downside
- Investors worried about further market declines can add explicit capital protection, increase allocation to high-quality bonds, or add capital to a dynamic asset allocation strategy. Investors can also consider adding positions in gold, longer-duration US Treasuries or private markets.
Prefer credit over equities
- We think stocks are priced for recession, but not as much as credit, which is closer to pricing in the worst-case scenario described above. US investment grade, US high-yield, hard currency emerging market sovereign bonds and short-dated Chinese high-yield property bonds all offer attractive opportunities, in our view.
Be selective in equity investing
- Focus on three key areas: (a) oversold stocks, (b) resilient stocks and (c) longer-term beneficiaries. In the case of oversold stocks, the sell-off in stocks has been broad-based, causing heavy losses in even high-quality companies with strong balance sheets. Quality cyclicals in semiconductors and industry consolidators in Chinese real estate might be options. Meanwhile, economic uncertainty increases the relative appeal of stocks that display resilient earnings growth. Some consumer staples, healthcare and communication services companies meet this criterion, and demand is relatively independent of economic cycles. And, while many changes to our lives prompted by the Covid-19 crisis will be short-lived, the pandemic will also accelerate some longer-term trends. For example, it could lead to wider adoption of technologies such as remote working, virtual learning and telemedicine. This in turn will boost investments in underlying enabling technologies such as 5G, artificial intelligence, big data and cloud computing.
Overall, it is imperative for investors to stay on top of their positions and manage risks proactively. Some may have to consider selling if their holdings are too large or too leveraged, and others should look to switch into higher-quality positions that are better leveraged to secular trends.
Remember, this too shall pass.
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