Johanna Kyrklund: It pays to be patient

As lockdown continues for millions of us across the world, unsure of when we will see loved ones or return to our places of work, we all know we must be patient. Good things come to those that wait, as they say.

This seems to me to be true not only from a personal viewpoint, but also from an investment one at the moment. While we are slightly increasing the levels of investment risk we’re willing to take on, we are being patient before raising the stakes.

Since this crisis broke it’s been difficult to focus on anything but the short term amid daily news flow and extreme market turbulence. But to compare investing in markets to driving a car, it’s really hard to do when you can only see six inches in front of the bonnet. The recent actions of governments and central banks have allowed us the space to refocus, lift our heads and look further down the road to the six to 12 months that lie ahead.

The actions of the Federal Reserve in particular, have reduced some of the tail risks (i.e. the risks of further negative events making matters even worse), particularly by stabilising the credit markets.  

There has been much talk of whether a potential economic recovery will look like a V, a U, an L or a W. My view is that expectations of a V-shaped recovery are too optimistic.  

It looks likely that some form of social restrictions is likely to persist into the third quarter and that the scale of this demand shock will cast a shadow over growth for the foreseeable future.

Remember that we have been commenting on the anaemic nature of economic growth for a number of years. Covid-19 only serves to reinforce our concerns that growth will be weaker, rather than stronger. 

In the longer term, with the massive stimulus measures that have been announced, there is also the risk of a significant build-up of public debt. This is an outcome which is likely to lead to even more financial repression, whereby interest rates are kept below the level of inflation.

The question is how much of this is already reflected in market prices. The current yield on the US 10-year Treasury (of around 0.62% at the time of writing) is consistent with the Federal Reserve keeping interest rates at 0% rates for the next couple of years.  

Although stock market indices, particularly the US S&P500, suggest that there is still too much optimism around corporate earnings, we continue to see a two-tier market. So-called “quality” and “growth” stocks are trading at expensive levels and “value” stocks look extremely cheap.

We think the US dollar, like other assets used as hedges against negative events, looks expensive.

On the Multi-Asset team we have become less positive towards the dollar, and also towards other hedges such as the Japanese yen, government bonds and gold.

The outlier for us is credit (corporate bonds), where the team has become more positive. Government action has altered the potential pay-off and their spreads (the difference between the yields on corporate and government bonds) look attractive, even after the strong rally that followed the Fed’s announcements.

With less emphasis on hedges and more emphasis on credit, our willingness to take on risk is a little bit higher.  

However, we are yet to take a more positive view on currencies or shares that are cyclical (i.e. most exposed to the global trade and manufacturing cycle). Ultimately, we decided that it was still too early to expect their comeback because the economic outlook remains cloudy.

Signs that the coronavirus infection rate may be flattening are welcome news in this context, but we are also conscious that, for now, the only way of containing the virus is through reduced levels of economic activity.  

Just as we need to be patient about our working and living arrangements, we believe that some patience is still needed before significantly increasing our exposure to those more economically-sensitive areas.

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