The pandemic has been an accelerant on many fronts – the end of the growth of globalisation, the rapidly greater use of technology and significant changes in our working patterns and consumer behaviour. For investors, it has also shaken up the way we are investing now and will in the future.
There are three distinct periods in which investors have and will need to make important decisions about the composition of their portfolios. Those are:
- Pre-COVID: Before financial markets began falling precipitously in February 2020.
- During COVID: Which spans from the beginning of the global spread of the disease until either a vaccine is widely available or the threat of the disease otherwise fades. Scientists tell us an available vaccine may be 2-2½ years away, so let’s estimate this period from early 2020 until mid-2022.
- Post-COVID: When we will know what the world looks like post-shutdowns, and beyond the inevitable shifts in economic and political arrangement to come. Let’s estimate this period spans from 2023-2030.
Looking back it seems quite simplistic to have been recommending staying fully invested for the first three quarters of 2020.
It was assumed that the US Presidential cycle would help ensure that the lead up to the fourth quarter was supportive for financial markets, and that indicated retaining full exposure to growth assets within individual asset allocations. President Trump would do everything he could to be re-elected and could then afford the economy and financial markets to slow down a little. So the time for a modest risk-off positioning was not until October.
Within growth assets investors were typically recommended to be overweight to alternative assets (private equity, private debt, infrastructure, property) and, on the defensive side, to retain both traditional bonds as well as credit as well as to retain term deposits on top of ready cash.
With the advent of COVID-19 this direction quickly changed and the fourth quarter could well be the time for putting risk back on. Initially in response to the virus, the emphasis was on ensuring there was sufficient cash in all portfolios for the next one to two years, inclusive of the ability to fully participate in attractive capital raisings as they emerged.
With cash rates now so low, term deposits are no longer attractive and higher interest call accounts are the place to be.
The second priority was on removing any sector- or security-specific risk, such as tourism/travel exposures, shopping malls.
The third priority is to consider for each portfolio an appropriate de-risking positioning in light of the remarkable disconnect between the high uncertainty of the pandemic’s impact on health and commerce and the extraordinarily fast recovery of asset prices after this biggest shock to markets in generations.
Individual examples of classic irrationality abound. Fangdd, a Shenzhen real estate company, jumped 395 per cent in one day in June on no corporate news — this was likely explainable by the FANG in its name.
Right here, right now in the full force of COVID, we are experiencing financial markets where the capacity for downside remains very high as we move into the months ahead.
Mid to late July we will see the second quarter GDP released and, while we think we are prepared, these numbers will be ugly and shocking and will likely trigger seriously negative sentiment.
As we move into August, corporate earnings will be released, and these numbers will be weak and only the bravest corporate chairs can be expected to pen cheerleading outlook statements.
September will see the likely withdrawal of fiscal support for many workers and businesses, though there will be pressure to retain an institutionalised basic wage, while the forbearance of credit providers may diminish. Businesses kept alive by forgiving creditors may topple into bankruptcy, triggering job losses and a potential double-dip recession.
Markets should react to these events and provide a cheaper and safer entry point back into growth assets in the fourth quarter. In fact many prominent fund managers are holding excess cash now waiting for this opportunity to deploy back into markets.
The expectation is that if lower prices do emerge, investors will stay at or close to fully invested over the remainder of the COVID period. Low interest rates and stimulus will prevail and the inclusion of active and diversified growth investing will be the only way to achieve average total portfolio returns (share price growth combined with dividends) of, say, 6 per cent.
There will be caution towards the US if the Democrats win control of the Senate in November and move to reverse tax cuts, institute a social wage and more heavily regulate the tech sector. The US market performance has been heavily driven by this sector, as well as tax cuts and leverage, rather than by profitability.
Sector and sub-sector exposure is also important, with appropriate weight to resources, utilities, telcos, technology, consumer staples, health care, logistics and financials forming the core of an equity portfolio.
We are a long way from 2023 but one thing we do need to give early thought to is the likely end of the disinflationary forces of nearly four decades. Globalisation, technology and demographics have all been disinflationary, but changes in the capital labour share and political and trade changes to global currency preferences are afoot.
It’s clear real assets will have a big part to play post-COVID. Real assets are defined as physical assets that have an intrinsic worth due to their substance. Property, precious metals, and commodities will have a big part to play in our world as investors in a post-COVID environment.