Fear in the Markets: the Smart Investor's Response
Investors come in different shapes and sizes, but right now they all have one thing in common: fear. The global stock market is down about 30 percent for 2020. The question of whether the United States stocks can sustain their decade-long bull run has been answered with a resounding "no."
While few would have predicted that a global pandemic would trigger the free-fall, the US is now formally in bear-market territory, having fallen over 28 percent from its peak in February 2020. The sell-off has been indiscriminate across most markets globally, even for traditionally "defensive" sectors like healthcare or utilities.
On the flip side, any government bond that's considered remotely safe has been in high demand, and US Treasury bond yields have reached new troughs before rebounding. Witness the proverbial "flight to safety."
Delicately Balanced, Which Way Will They Tip?
Imagine current volatility as a weighing scale. On one side are investors, fearful of how much worse the coronavirus will transpire.
On the other side are global authorities who have not held back on taking measures: border controls to limit viral spread; monetary stimulus to lower the cost of corporate debt and fiscal stimulus to support vulnerable consumers and businesses.
The US Fed has led by cutting interest rates to zero, the European Central Bank has increased quantitative easing and around 30 central banks have followed rate cuts. Attention is now focused on how much fiscal stimulus governments globally will inject.
Investors are eagerly processing each piece of information as the economic damage turns more severe than initially expected. When the implications are unclear, they may well feel that the only safe option is to sell now and figure it all out later. It is no surprise that markets will remain choppy and volatile in the near term.
Take a Breath and Don't Panic
One of the worst things an investor can do right now is sell-all, or a substantial chunk, of their equities – especially if they've already suffered significant losses. In volatile times, market movements (up or down) tend to be larger than normal. So, if you've cashed out, you risk missing out on big recoveries.
In fact, according to data from 2004 to 2014, portfolios that missed out on the top 20 performing days during this period would have significantly underperformed. Where "timing the market" is notoriously difficult, investors should focus on "time in the market."
Prepare for Volatility Over the Coming Months
We expect the economic outlook to remain uncertain, with seesawing markets and persistent volatility and have made several short-term (3 months' view) changes to our investment views.
We are downgrading global equities from overweight to neutral, on the expectation that corporate earnings will deteriorate significantly, particularly in developed markets. We still think equities are an attractive investment over the long-term but caution is warranted for now. We stress this is a modest reduction and NOT a call to sell everything.
We are upgrading investment-grade corporate bonds from underweight to neutral. With yields on government bonds now even lower, the excess yield available on investment-grade corporate bonds looks more attractive. Corporate bonds are also more reasonably priced, and reflect some of the risks of a global recession, as well as deterioration in corporate earnings.
Although we're maintaining our underweight position on core government bonds, we acknowledge that they still have a place in a diversified portfolio. While these assets have performed well during volatile times, with their yields at an unprecedented low, we do have concerns about their ability to rally much further (and offer the same diversification benefits).
Nonetheless, they should continue to hold up well in the current volatility. It's vital that you take steps now to optimize your portfolio while ensuring the right level of exposure for your risk tolerance. This means including high-quality bonds and viewing these allocations as a form of short-term portfolio insurance.
Look for 'Smart Diversifiers'
Since traditional safe-haven assets are expensive, there's no cheap or easy place to hide. We've mentioned investment-grade corporate bonds as an alternative, but stress that since these bonds are issued by companies and not governments, they do have a higher correlation with the stock market.
Because of this, investors should consider additional ways of diversifying. Alternative investment strategies aim to deliver absolute returns uncorrelated to market conditions.
Gold is another asset that traditionally performs well during volatility. Although prices recently reached a seven-year peak, it is still a useful store of value at times like these and we expect prices to be supported by even lower interest rates and continued short-term volatility.
If neither of these approaches is readily available, contemplate a more traditional multi-asset portfolio approach, where investment decisions are made by professionals against your risk target.
Consider Opportunities for the Long-Term
With uncertainty comes opportunity. This matters to investors because cheaper entry points to global equity markets now exist and prospective returns on equities are now higher than before, making them more attractive for investors with a longer-term time horizon.
Remember that it's difficult to time the market and call the absolute bottom so let's pore over the opportunities. Within equities, we think that Emerging Market (EM) equities, particularly in Asia are attractive from a long-term perspective.
EM has more scope for policy action than the Eurozone and Japan, as we've already seen authorities in mainland China and other Asian markets take aggressive fiscal and monetary action to support the economy.
Lower energy prices should also help EM markets that are "non-petroleum" economies. Because Asia was forced to confront the coronavirus a few months before the rest of the world, it is arguably closer to returning to some semblance of a normal life as infection rates appear under control. This can be positive for Asian economies and, correspondingly, for EM and Asian investments.
Xian Chan is the global head of wealth insights, wealth and personal banking at HSBCTags: