Recognizing the unprecedented speed of market reaction to the COVID-19 pandemic, our investment leaders provide views on tactical asset allocation, rebalancing considerations and trading conditions in fixed income markets.
Based on our internal data, most portfolios are underweight equities 5%-8%. However, policy and practicality need to be considered in present trading conditions.
Liquidity in fixed income markets has improved through Federal Reserve action but remains tighter than normal.
Expect poor economic data over the next several weeks and remember period will be prior to policy responses.
Global Head of Fixed Income Portfolio Strategy
What a sharp difference five weeks have made in investment portfolios. The MSCI World Index reached the 30% drawdown mark in only 25 trading days (as of 3/26/2020), lightning fast compared to prior crises - 166 days during Great Financial Crisis and 241 days when the tech bubble burst in 2001*. Investors viscerally knew velocity, and volatility, were swift and the numbers underscore the shocking pace of the drop in global equity markets.
We asked our experts to address some critical questions posed by our clients. Each client is unique. Our objective is to address common concerns at a high level rather than provide one-size-fits-all perspective. One of our relationship managers would be happy to separately discuss specific questions.
1. How do you evaluate portfolio positioning when markets are moving at this speed?
We think understanding investor sentiment is key when markets are moving fast. We use our proprietary tool, the Market Regime Indicator (MRI) for this purpose. It’s a forward-looking model incorporating real-time market pricing of risk, specifically global credit spreads, equity implied volatility, and currency implied volatility. These factors are combined into a single measure which identifies one of five risk regimes: Euphoria, Low Risk, Normal, High Risk and Crisis.
THE MRI quickly changed to a Crisis regime when the coronavirus spread outside China and indicates the same today. A Crisis regime typically shows that investors have become excessively fearful and consequently signals an opportunity to add to risk assets. However, the coronavirus situation is more medically driven than economic, so we are taking this signal with awareness of the distinction.
Overall, we expect the economic impact to be painful in the second quarter, but relatively short lived due to containment measures and the significant policy response. Investors should certainly be prepared for difficult economic releases over the next several weeks. We are looking further ahead - policy supports are helping bring volatility down, particularly in longer- dated VIX metrics. In time, investors will have more clarity and confidence to form expectations.
2. What could indicate that markets are starting to bottom, even turn to recovery?
A few key things we are looking for are: (1) a peak in virus cases and a slowdown in the rate of acceleration of the virus, (2) reconcilement between top-down and bottom-up earnings estimates (top-down figures have been adjusted but changes to bottom-up will not be until earnings season beings in April), and (3) signals from the MRI stabilize. Technical signals may also help, but these can also signal a short-term bounce.
3. The end of the quarter might be a natural rebalancing period. How are you approaching this given the wide swings in market prices?
Based on our internal data, multi-asset portfolios are underweight public equities anywhere between 3% and 10%, with most portfolios between 5%-8% underweight. So, a sizable rebalance could be coming; yet both policy and practicality need to be considered in present market conditions. Liquidity can be challenging, particularly for selling fixed income assets. Trades will probably get done but the pricing may be weaker than an investor might like.
4. If you rebalance, what pricing could an investor expect in Fixed Income markets?
Liquidity in Fixed Income is tighter than normal but has improved due to the Federal Reserve’s enormous actions. Fresh liquidity and a willingness to buy assets have helped improve market making. Also, trading conditions are nowhere near those in 2008 when bid activity evaporated. Today, we are receiving bids for 60%-70% of portfolios. As we said above, trades are getting done but at softer prices.
Treasuries, investment grade and high yield markets show some early signs of improvement. Last week, the dispersion of bids for Treasuries was roughly 10 times higher than in normal markets and that has narrowed to 5-7 times. Credit markets are improving as details on the Federal fiscal stimulus emerge, but spreads are still rather wide. Selling in high yield is a challenge as buyers are interested in names deeply undervalued on a technical or fundamental basis.
5. Wrapping up, any closing thoughts for investors?
We are not out of the woods yet and we anticipate poor headlines and potential market volatility from upcoming economic releases. More turbulence is probably ahead. Thus, we believe flexibility in rebalancing decisions will benefit investors.
Nonetheless, we have seen improvement on three of the four key factors where we think the markets need clarification. The spread of the COVID-19 virus is the biggest unknown, but we hope to see cases peak in Europe soon and infection rates to slow elsewhere. Second, central banks, especially the Federal Reserve, are actively using monetary policy tools to aid liquidity challenges – and it's helping trading conditions. Third, the US government appears to be nearing agreement on a multi-trillion stimulus package to help soften the economic blow. The remaining factor we have not seen improvement is the oil price war. We continue to actively monitor conditions and address client concerns. A long-term perspective is perhaps the best medicine during the COVID-19 outbreak.
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