Joseph Little, Global Chief Strategist, HSBC Global Asset Management, shares his investment outlook with NextMoney. Here’s what to expect for the remainder of 2020:
The COVID-19 pandemic brought the world economy to a sudden stop in the first half of 2020. Despite a rapid and bold policy response, global growth collapsed, with subsequent economic and market shockwaves being too numerous to list in full.
A big question for investors is how fast the macro system can restart. Clearly, the virus needs to be manageable, which means we need case growth to slow meaningfully, as well as a wider roll-out of testing and tracing. In principle, the system should be able to recover quickly from this type of self-enforced closure. However, it’s reasonable to expect setbacks and a full recovery may take time.
Possible realities for the macro-economy
There are many possible outcomes for the macro system and investors need to think probabilistically while regularly updating their scenarios. Our baseline is for more of a swoosh-shaped recovery. This entails a sharp rebound once lockdowns are lifted, and then a gradual pickup to pre-crisis levels of activity.
Working backwards, it means the recovery has begun already in this quarter. By the end of next year, the global economy should be fully established on a new, lower trajectory, but a roughly similar trend growth rate. The best positioned economies belong to China and industrialised Asia, such as South Korea, Taiwan and Singapore. Less resilient are emerging markets ex-Asia, smaller oil exporters, frontier nations and the Eurozone.
There are some downside risks to this scenario. Economies have differing capacities to deal with crises, for example, around policy flexibility. The risks of a second wave of infections and economies suffering permanent damage also loom. But the biggest risk, in our view, is a policy mistake. The global crisis-mode response has been as good as we could have hoped. But, following the liquidity measures, solvency challenges remain. We also question whether a form of ‘stimulus fatigue’ could eventually set in, with policy support ending too soon. That said, there is plenty of capacity to use up before inflation becomes a risk and investors seem readier than ever to let governments break fiscal taboos.
Steep trade-off between risk and returns
The current crisis has accentuated the already steep trade-off between risk and returns. Current prices suggest sub-inflation returns for core government bonds over the medium term, while riskier asset classes are discounting much higher rewards.
With government bonds not being attractive from a valuation perspective and their hedging properties becoming increasingly limited as interest rates approach zero, investors need to think harder about how they diversify.
We currently favour global equities and high-yield bonds on a strategic, long-term basis. In equities, while the crisis represents a challenge for the global economy and profit cycle, lower prices this year have increased our measure of prospective returns. We think that investors willing to absorb near term volatility will be compensated over the next couple of years. Lower developed market government bond yields have also increased the relative attractiveness of equities over bonds, while substantial policy easing has reduced downside tail risks for equities.
Spreads on high yield bonds are relatively high in our view and the credit risk premium – the compensation for bearing corporate default risk – looks attractive. We continue to prefer Asian credits to developed market ones as they continue to offer higher spreads for similar credit risk, and the region is well positioned for recovery. Policy support in China will also be important for this asset class.
Alternatives – liquid and illiquid – should start playing a greater role in portfolios too. We particularly favour strategies that offer low correlation to traditional asset classes and downside protection from equity downside risks. Strategies like style premia, trend following, equity factors such as “quality”, and some liquid hedge fund strategies can prove useful in this environment. We also like private equity as it can offer an opportunity for return enhancement. However, illiquidity and leverage mean this investment is not adequate for all types of investors.
Finally, it’s likely that the current pandemic is accelerating economic and social trends that were already in play before the crisis. Trends such as the increased take up of technology and a focus on sustainability are impacting all asset classes and, together with the market reaction to the crisis, create selective opportunities, with a greater emphasis on regional allocation, styles and sectors.