COVID-19: the asset allocation debate

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The latest analysis of global markets by Invesco’s Market Strategy team has concluded that, in the context of the Covid-19 virus, a worst-case scenario will be global GDP shrinking by 3.5% in 2020, with the S&P500 at 1,400 in 12 months’ time, gold at USD1,750 and Brent at USD20.

This scenario is one of four possible outcomes predicted by the multi-asset team: in their very best case, global GDP growth would slow to 2% in 2020 (versus an original expectation of 3%), with the S&P500 at 3,000 in 12 months, gold at USD1,325 per ounce and Brent crude at USD45 per barrel.

The scenarios have been published in the latest Big Picture quarterly market review, published by the Invesco Global Market Strategy Office.

Paul Jackson, Global Head of Asset Allocation Research, Global Thought Leadership, Invesco, says: “This is not the year we were expecting, nor do we know how it will end. Anything seems possible. It is easy to panic and run for the hills – both literally and by adopting an extremely defensive portfolio stance – but it is not obvious which assets now offer diversification. Cash seems to be the one asset that has remained decorrelated but that could change if the banks have problems.”

Invesco’s multi-asset experts have run portfolio optimisations based on all four scenarios as well as on a probability-weighted average. Although they believe that equities (except in the US) offer good returns in optimistic scenarios after CAPEs have fallen toward 10 in some regions, they doubt that will stop them getting cheaper over the coming months if there is a deep global recession.

Their models suggest a barbell approach that overweights “defensive” cash and gold but also more cyclical commodities and real estate as assets offering good value on a long-term basis. “Gold has lost some of its froth and could still rise in the worst scenarios,” Jackson notes. “Commodities are now cheap, especially oil, and yields on real estate have risen dramatically over recent weeks, offering the chance of attractive returns in all but the very worst outcomes.”

In addition, investment-grade credit (IG) is favoured under all scenarios. Geographically, the Invesco experts prefer UK, Japanese and emerging markets (EM) assets, with most EM assets currently offering wider spreads than is usual versus developed markets.

Sector impacts – positive and negative

Invesco’s multi-asset team expect service sectors to be less impacted than industrial sectors. On this basis, the US economy looks to be better placed than most, especially given the relative lack of dependence on trade flows. While some sectors – such as travel and leisure – cannot operate in the present circumstances, others will benefit, including medical equipment manufacturers, toilet paper makers, hand sanitiser producers and food manufacturers and retailers.

Year-to-date stock market performance shows relatively strong performance from the following sectors: retailers, food, beverage & tobacco and personal care, drug & grocery stores. Unsurprisingly, the healthcare sector has done even better, given the search for an effective vaccine and the need for public sector healthcare providers to procure private sector resources.

With respect to financial market reactions, Jackson and his team can imagine three potential panic circuit breakers: first, a peaking of non-Chinese Covid-19 cases and deaths; second, a policy response that provides ‘shock and awe’ to financial markets and protects the cash flows of businesses and households and, finally, the development of a viable vaccine (and treatments).

Given that an effective and approved vaccine appears to be at least 12 months away, hope rests with efforts to quell the outbreak and the fiscal and monetary responses to the consequent economic crisis.

“Reminiscent of the global financial crisis, such policy initiatives are arriving thick and fast and in ever increasing sizes. However, these efforts to facilitate loan growth depend upon the willingness of the banks and their customers to enter such arrangements, and it looks increasingly as though governments will have to step in to replace normal sources of income. We think such measures will become widespread but at a cost,” Jackson says. “It is not far-fetched to imagine that budget deficits could reach 10%-20% of GDP this year, a level more associated with war.”

The damage suffered by the Chinese economy during the first quarter of 2020 remains unknown but declines in retail sales and fixed asset investment suggest that China’s GDP will have declined during Q1.

As such, Invesco’s multi-asset experts think other economies will go through a similar process during late Q1 and early Q2. On this basis, they consider a technical recession (two quarters of negative growth) a possibility at the global level, with full-year growth depending on how rapidly normality is restored and lost production recovered. “Today’s policy choices will determine the extent of the downturn and the speed of the recovery,” Jackson concludes.


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