Investment Strategy: Taking a small step into riskier assets

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The outbreak of the coronavirus triggered a small correction in stock markets. This was not surprising. And the quick recovery in markets also not. Putting aside the devastation that the illness has already brought to the victims and their families, the market’s recovery from the coronavirus-related correction indicates strength and resilience. The question is: why are markets so resilient?

We believe that there are a number of strong forces that are supporting global financial markets and, in particular, equity markets. These forces include the low level of interest rates, which is driving investors to look for alternatives to very low, or even, negative yielding bonds. Further, the continued accommodative stance of central banks is also providing strong support for stock markets. The quick market recovery following earlier incidents, for example, related to Brexit or the conflict between the US and Iran, and now, the outbreak of coronavirus, is evidence that these underlying forces are strong enough to overcome relatively short-term adverse events.

Against this backdrop, the ABN AMRO Investment Committee decided to take steps to increase risk in the portfolio. These changes include a small increase in stocks (moving from neutral to slightly overweight) and putting cash to work in bond portfolios by, for example, reducing high-quality but low-return, eurozone government bonds, and using the (cash) proceeds to invest in corporate bonds and emerging-markets debt. The asset allocation now reflects a slightly stronger preference for stocks (modest overweight), while bonds continue to be underweight, although slightly less so than before the changes.

ABN AMRO’s expectations for the global economy have not changed. We still expect a weak first half of 2020, followed by a somewhat stronger second half of the year. The outbreak of the coronavirus, however, is likely to have an effect on both halves. In the first half of the year, economic growth may be slower than previously expected, but with more of a ‘catch-up’ coming later in the year.

In terms of regions, we believe that China’s economy will be the worst affected, as quarantines, travel restrictions and the impact on labour markets and supply chains are felt. Despite the significant health effects of the virus, the negative impact on the global economy is widely expected to be transient. Chinese policymakers are already taking steps to increase stimulus and support liquidity.

The modest increase in stocks by the Investment Committee did not lead to any changes regarding regional or sector allocations. The US (small overweight) continues to be preferred based on the relatively strong outlook for economic growth and company earnings. Within the bond portfolio, investment-grade corporate bonds remain the anchor of the portfolio and are preferred over higher quality bonds with lower yields. Higher returns (in line with higher risk) can be found in emerging-markets debt. Emerging market sovereign bonds, for example, do not pose significant default risk, given the absence of major budget or current account deficits. For some investors, cash can also be considered an option to low- or negative-yielding bonds.

In our Investment Outlook for 2020, “A break in the clouds,” we indicated that we saw some potentially positive developments on the horizon. Even though the current macroeconomic picture remains mixed, there are increasing signs that fundamentals are bottoming out. The modest step taken to increase riskier assets is a reflection of this muted optimism.

Richard de Groot
Chair, ABN AMRO Investment Committee