Asset Allocation

Reinhard Pfingsten

Global Head Asset Allocation Services

Lessons from history

4 June 2020 - One thing is clear - every economic and financial crisis is different. And for sure so is the Covid-19 crisis. We have never experienced a such global lockdown of economic activities at this scale, much as we have not previously seen such large support from fiscal and monetary policies. Nonetheless, there are some common observations possible, including behaviour in bear markets and what happens before and after a trough in markets.

In the seven bear markets since World War II, we have seen an average market correction of 34.5% (as measured by the S&P 500 Index). Usually, these corrections take place over a period of 14 months - not 1 month, as we have seen in 2020. Relief rallies, as occurred in April, are also not uncommon, before markets later retest their former lows. We believe this 'double-dip' scenario could also happen this time. While economies are beginning to exit lockdown periods, we also observe that the rising debt levels of governments, companies, and private businesses create a significant burden.

For sure, economic activity in the longer term will come back to levels seen before. And capital markets will price-in such growth ahead of time. So let's look at what happens with different asset classes through such periods, based on data from the seven most severe corrections since 2000.

Asset class performance before, during, and after severe market corrections

After the trough, there is a preference for US equities, which we also now prefer. Emerging markets also show some strength, but if the details are reviewed, a high dispersion can be seen among the different crises and also between different countries.

Regarding commodities, there is no short-term preference, but in the longer term, economic growth causes a rebound in commodities demand.

If you go into the structure of equity markets, you can see that there is a preference after a trough for information technology and communication services, which have also been (and we believe will be) the structural winner of this time. In the past, the lagging sectors were health care, energy, and utilities. Maybe this time health care, due to the nature of the crises, will be different.

Also several factors, which describe the performance of stocks, such as growth, value, momentum and quality, present an interesting picture. In particular, focusing on earnings quality as a factor has shown a clear out-performance compared to other equity factors.

If we analyse the data for fixed-income markets, there is a preference for US high yield. However, there is also a high dispersion between the different cycles, which means there is higher uncertainty. At the same time, you have a lot of US energy companies in the high-yield segment, which also creates uncertainty. The outcome and preference for investment-grade corporate bonds has shown much more stability and solid performance. A lagging segment after the initial crash, however, is US Treasury markets.

This crisis is definitely different. But market behaviour is repeating. Or as Mark Twain (Samuel Clemens) said, "History doesn't repeat itself, but it often rhymes."

Reinhard Pfingsten - Global Head Asset Allocation Services