Five months ago, share markets were roaring ahead, reaching new highs on 19 February just as COVID-19 had started moving beyond China. By 23 March, the S&P 500 had fallen by 34 per cent and the ASX 200 was down 37 per cent as new cases worldwide accelerated past 40,000 per day.
Whilst COVID-19 hit market confidence with unprecedented rapidity, the recovery in markets since their late March trough has been equally as stunning, particularly against a backdrop of major economic disruption from lockdowns and global trade disruption. The enormous infusion of liquidity by central banks and fiscal spending by governments around the world in response to the crisis had a major positive impact on markets.
However, from an investment perspective, the environment remains highly uncertain. We question the sustainability of the recovery in markets thus far and remain cautious for the potential for renewed volatility. There is an increasing concern that the bounce in markets is looking like FOMO (fear of missing out) or TINA (there is no alternative) – rather than being predicated on sound investment reasoning.
We are also concerned that whilst the actions of central banks and governments have produced a major boost to markets thus far, the benefit to longer-term economic growth is less clear. It buys time only, rather than providing the solution.
Investors, faced with evidence of extreme economic distress in the short-term, have been increasingly willing to take a longer-term “look-through” view. This has been underpinned by indications that the impact of COVID-19 is now waning in many of the countries initially impacted.
The irony is that the flattening of the infection curve has only been possible because of the severity of lockdowns, which have in turn produced a savage economic slump. This has become clearer in some instances where countries have opted to prematurely relax social restrictions and lockdowns to boost economic activity, only to see a renewed surge in infection rates.
This raises the question as to whether we can realistically see a quick and sustained bounce in growth back to pre-COVID levels, or whether it is more probable that there is a longer and painful economic overhang? In our view, there is a high potential for ongoing effects from COVID-19 to have a more lasting negative overhang on the global economy.
Given these concerns, there are some basic strategies to help investors manage through this crisis. Just as we cautioned against panicked selling during the market rout, we now feel investors should be equally cautious about rushing to invest in markets that are looking increasingly overstretched given the uncertain outlook.
As was our belief prior to the outbreak of COVID-19, we are of the view that markets are once again pricing in a rosy environment that may not eventuate. Government bonds offering long-term yields of less than 1 per cent are not great long-term value and may not offer as much protection for portfolios moving forward. Similarly, global share markets, having bounced between 25 per cent and 40 per cent since March, appear to not be adequately pricing in risk at the moment.
So, in our view, avoid chasing markets in this environment. Keep some powder dry by holding a bit of extra liquidity and more defensive assets within portfolios. Cash serves both purposes. It doesn’t return much but it does provide the option of being able to quickly respond should renewed volatility open up buying opportunities.
Secondly, maintain high levels of diversification in portfolios. Look for investments that are relatively uncorrelated to shares to help deliver more all-weather portfolio resilience should share markets take another tumble.
What is perhaps not appreciated is that unhedged international shares can make a good portfolio diversifier. This seems counterintuitive given that much of the recent crisis has centred in offshore economies, particularly the US, whilst Australia was a relatively less affected (as measured by infection and mortality rates).
The depreciation of the Australian dollar during this period however, placed a floor under the value of overseas investments, even whilst share markets themselves sold off around the world. Now that the Aussie dollar has rebounded to near US70 cents, unhedged offshore investments can again provide a potential buffer in the event of a second wave of volatility.
There remains a danger that investors are being lulled into a false sense of security given the swiftness and magnitude of the market recovery as the current environment remains highly unstable and uncertain. This suggests that investors, in our view, should prepare their portfolios for continued volatility ahead.
Michael Karagianis, senior consultant for retail partnerships at JANA.
