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Asset allocation – Opportunities in the crisis

Global views and trends

Maximilian MOLDASCHL

Flash note - 30 March 2020

  • Economic disruption and resumption: The latest data shows the huge damage of the measures to contain the virus outbreak in the Western world: purchasing manager activity have plummeted in Europe and the US, and US jobless claims hit a high. In China, economic activity is gradually resuming, with industrial production leading consumer activity.
  • Policy responses: Huge, and in some cases unlimited, monetary and fiscal packages are in place in Europe and the US to support the economy.
  • Market stress: Sentiment measures are showing early signs of consolidation. Market volatility metrics have started to ease after the colossal policy measures.
  • Fundamental views: Ultimately, we expect a ‘U-shaped’ recovery that will likely require ‘learning to live with the virus’ via innovations in testing and involve a gradual economic resumption. The main downside risk is prolonged and intermittent shutdowns.
  • Strategy: We are now neutral US equities, favouring UK equities and commodities. We are long AUD/USD. We remain overweight eurozone and emerging market equities.

The virus is spreading from east to west. The eye of the storm is now in Europe, but the US is starting to suffer the full force. Last week, the US overtook China in terms of confirmed cases. In Asia, the number of new cases remains contained and low. In China, the growth rate of new cases has been stable and close to zero. In South Korea, the growth rate has remained low at below 1%.

We remain attentive to a potential major breakthrough in terms of mass testing capabilities or finding and testing a vaccine. At the time of writing, we had not identified any significant breakthroughs.

Macro disruption and business resumption

The latest number are showing the economic cost of the pandemic. Surveys of economic sentiment have plunged in Europe and the US. In Europe, the services purchasing managers index fell to its lowest since records began. The manufacturing index was hit hard. In the US, the pattern was similar.

US initial jobless claims soared its highest on record, highlighting the very sudden shutdown of many businesses.

There appears to be light at the end of the tunnel in Asia. In China, for example, economic activity is gradually resuming, though to varying degrees across sectors. In sectors equivalent to 65% of GDP, activity is back to 86% of normal levels. The ‘new normal’ of around 90% is expected in early April.

Policy responses

Policy responses have been of unprecedented magnitudes. The US Federal Reserve announced ‘unlimited’ quantitative easing and the ECB set a EUR 750 billion emergency bond purchase programme. The Fed is now back in deep easing territory with policy rates effectively at zero and a massive QE programme that aims at keeping monetary conditions loose for the foreseeable future.

On the fiscal front, the US approved a USD 2 trillion package, equivalent to about 10% of GDP (see exhibit 1). Large fiscal easing programmes are also in place in Europe. China has eased fiscal policy to the tune of USD 344 billion. But its effort as a percentage of GDP is more contained and more targeted.  This reflects the authorities; concerns about excessive leverage. The measures aim to help SMEs, vulnerable populations and regions and support infrastructure projects such as smart cities.

Exhibit 1: Fiscal packages compared (% GDP)

asset allocation flash 2020 03 30

Source: Bloomberg and BNPP AM, as of 27/03/2020

Sentiment and systemic market stresses

Sentiment has recently shown tentative signs of consolidation. There has been a slight drop in the number of Bloomberg ‘virus’ news stories.

Indicators of systemic stress have not become unhinged, partly due to the aggressive liquidity measures by global central banks.

Finally, volatility has started to ease, also supported by the massive policy measures in major economies.

Recent changes to positioning

Since our previous Asset Allocation Flash note, we tweaked the regional and asset class focus of our risk asset exposure.

We expect the combination of unlimited Fed QE and the trillion dollar fiscal package to support the market. It will not necessarily mark the bottom of the cycle for US equities as the coronavirus hits the US, raising concerns about the economic outlook. In addition, valuations, while below historical averages, have not adjusted by as much as those of other risky assets such as UK equities.

We have more conviction on UK equities and cyclical commodities. After the recent violent price action, commodities are at levels not seen since the 1970s. Note that commodities usually outperform in early stages of a recovery and commodity assets would be supported in reflationary scenarios.

In light of this, we trimmed our US equity view to neutral, favouring UK equites, global commodities (excluding agricultural commodities), and a long AUD/USD trade.

This is an extract from our 30 March Asset Allocation Flash note entitled Opportunities in the crisis

Views expressed are those of the Investment Committee of MAQS, as of end-March 2020. Individual portfolio management teams outside of MAQS may hold different views and may make different investment decisions for different clients.

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