Is there an opportunity with equities?
Only last summer did we mention, with a hint of irony, the “imminent collapse of equities” based on a deluge of headlines and news that pointed to an impending market correction.
At the time, we stated that although economic variables indicated a slowdown, the probability of significant corrections was low given the counter-cyclical measures deployed around the world, and just as importantly the fact that not only were the bulk of investors underweight on risk assets, investment flows were even heading out of equities.
A short time later – in the autumn – we again pointed out that economic growth variables were improving and trade tensions relaxing. We discussed whether or not it would be suitable to continue investing, emphasising the importance of not succumbing to the temptation of profit-taking without having a plan for subsequently investing again.
These reflections now seem in the distant past. In early February 2020, the markets digested a flow of information that once again posed questions regarding what steps to take, i.e. should I invest now? Or should I wait for a scenario that offers greater clarity?
The ups and downs of the market
The global economic growth narrative has attracted followers in recent months. However, it has again been cast into doubt by two ‘black swans‘:
The geopolitical problem was quickly dispelled when the military escalation between the two nations subsided, while the risk of a global pandemic seems – at the time of writing – to be contained.
Without wishing to downplay the severity of the virus, it seems clear that markets overreacted to the news, with sharp price adjustments for commodities such as industrial metals, which tumbled 10% on average, and oil, which at one point fell by around 20%. Cyclical equity sectors were not immune to the trend, likewise being hit by significant corrections.
So far the measures implemented to contain the virus show similarities to those deployed during the SARS outbreak of 2003. In China, in particular, the impact had by the epidemic was short-lived, largely being restricted to the second quarter 2003, when real GDP growth fell to 9.1% (compared to 11.1% in the first quarter), followed by a robust recovery of 10% in the second half. As is now the case, the hardest-hit sectors were retail, tourism and transport.
Addicted to stimuli?
The impact of the coronavirus looks set to be limited – unless it becomes a global pandemic – with the disruption likely to postpone but not suppress economic growth.
It remains ironic that it was the coronavirus rather than trade tensions with the US that drove China to implement fresh stimulus measures, cutting interest rates and injecting liquidity into the system (RMB 1.6 trillion/USD 231 billion) while boosting consumer credit.
Some analysts expect Beijing to respond aggressively with fiscal and monetary stimuli that could generate a “V” recovery spearheaded by the industrial sector. In particular, factory output has been less affected because the crisis happened during the Chinese New Year when factories generally close.
Between seasonality and the presidential election cycle.
Using the S&P500 as a benchmark based on the index’s long history and the influence of the US market on global equities, February tends to be a weak month in seasonal terms, showing an average return of -0.2% and positive variations only 53% of the time. However, returns in the fourth year of a US presidential legislature have historically been positive! All of which indicates that market corrections – should there be any – could represent a window of opportunity to establish more aggressive positions.
That said, one possible source of market volatility could be normalisation of the Fed balance sheet, bearing in mind that the central bank has again expanded its balance sheet to stimulate the repo market. Powell has repeatedly stated that this expansion does not represent quantitative easing (QE), but many market agents believe otherwise. Even the President of the Dallas Fed, Robert Kaplan, indicated that the effect of Federal Reserve purchases is similar to QE. The debate among analysts as to when the balance sheet will normalise centres on the month of June.
To invest or not to invest? That is the question.
We again face the question that arises time and again. Indeed, opportunities tend to emerge (usually associated with uncertainty and market volatility) right at a time when investors are not willing to take risks. The opposite also applies, there are investors who feel “more secure” when the scenario is more stable.
Market valuations remain tight (as they have been during recent years), but the scenario seems constructive, while the accommodative positioning of central banks together with global growth prospects should underpin the performance of risk assets over the coming months. In particular, in terms of positioning, investor flows are returning to equities and are yet to reach any extreme levels that might trigger caution warnings.
That said, we remain upbeat on the asset, but would add that investment decisions should not be based solely on market outlook, as this is only one part of the picture. Asset distribution and risk management always comprise the core aspects of any investment process.
We again urge you to consult with your financial advisor, who will be able to point you towards the options and products that best suit your profile and risk tolerance.