Investment Strategy - Volatility ahead

News item -

Large market fluctuations are occurring in response to the continued spread of the coronavirus and the actions of governments and central banks to avert an economic crisis. Given heightened market uncertainty, the ABN AMRO Investment Committee is maintaining its neutral stance toward stocks, while government bonds remain out of favour and we remain positive about emerging markets debt (EMD).

It is safe to say that what we are all experiencing now in terms of health risks and consequences is unprecedented in our lifetimes. In this period, when we are concerned about the health of our families and other loved ones, financial markets can seem irrelevant or at least distant. We want you to know, before we fill you in on our investment strategy, that we wish you and your families good health and the strength to persevere during these difficult times. We look forward to when we can all breathe a sigh of relief that these exceptional times are behind us.

Sentiment regarding the coronavirus has been driving markets over the past weeks and this is set to continue. Until the extent of the effect of the virus is able to be estimated, based on testing or infections peaking and then receding, markets will likely remain in turmoil. There have been big swings in equity markets, both up and down, and significant changes in bond yields. Given the high level of uncertainty and continued market volatility, the ABN AMRO Investment Committee decided to make no changes to its asset allocation, which continues to reflect a neutral stance toward stocks, while government bonds remain out of favour and we remain positive about EMD.

Short-term economic outlook is bleak

ABN AMRO has revised its economic outlook downward. Forecasts were slashed owing to the global outbreak of the coronavirus and its effects on people and markets. The downgrades are owing to tightening financial conditions, declines in output that will lead to rising unemployment, financial stress for companies and supply side disruptions. US economic growth is expected to be negative (-1.4%) this year, rising to 3.2% in 2021. The outlook for the eurozone is even weaker, with economic growth of -2.7% in 2020, rising to 1.9% in 2021. China’s economy is expected to decline to 4.5% growth in 2020, with 6.5% expected in 2021.

Moving toward the ‘severe shock’ scenario

The Investment Committee has been evaluating market circumstances along three different scenarios: transient shock, prolonged shock and severe shock. It is now acknowledged that we are moving toward, or have already arrived at, the severe shock scenario, which implies a global recession. The reason is that many of the criteria for the severe shock scenario are now being met. This includes the global spread of the virus and its becoming a pandemic, ‘lock downs’ of populations and widespread travel bans. Despite these severe characteristics, the scenario also calls for a pickup in activity beginning in the third quarter of this year, with continued strengthening into 2021. The depths of the slowdown and the timing and size of the recovery are contingent on the spread of the virus and its subsequent containment. Market sentiment will likely respond in line. As long as infections continue to rise, good visibility into future market outcomes is limited.

Central banks and governments step in

In the meantime, there have been sizable and significant actions by central banks and governments around the world. The US Federal Reserve and the European Central Bank (ECB) are ready to do whatever it takes to cushion the effects of having large regions around the world at an economic standstill.

The Federal Reserve has significantly strengthened liquidity and added backstops to financial markets. Its asset purchasing will also now include investment-grade bonds. For the eurozone as a whole, the fiscal and liquidity measures total around EUR 2 trillion (around 18% of GDP). Most of this comes from liquidity measures, though the fiscal support is also substantial. In the US, a USD 2 trillion dollar stimulus was approved by the US Senate, designed to support workers, companies and families. While direct coordination between all the global parties may be difficult to discern, there is certainly the feeling that public institutions and governments around the world understand that we are all in this together.

Market review

Equity markets are firmly in bear market territory, defined as fall of 20% or more from a recent peak. Equities continue to be driven by the challenge of not knowing how the virus is going to develop. Markets found some support in the stimulus measures taken by governments, and, in particular, in the US. But volatility remains high. Daily swings of over 3% used to be very rare, but have become almost normal over the last weeks. On a year-to-date basis, the Chinese stock market has clearly outperformed the US and, in particular, European markets.

Bond markets are being supported by the actions of central banks, but adequate liquidity is a concern. Given the market turmoil that we are currently experiencing, it is not unexpected that liquidity for riskier bond segments, such as high yield and emerging markets, is drying up. Credit spreads are also quickly rising. We have also seen liquidity issues in the investment-grade bond segment. This is expected to improve, given the unprecedented steps taken by central banks. The significant actions by central banks should also lessen investor concern about the growing deficits that governments are assuming as they pump fiscal stimulus into their economies.

Decision regarding market drift

The significant volatility in markets over the past few weeks has led to shifting periods of ‘market drift’ in our allocations to stocks and bonds. The ABN AMRO Investment Committee is monitoring what can, in very volatile markets, become temporary discrepancies between the stated allocation and the actual situation within portfolios. For individual stock portfolios where the drift has led to a significant deviation (e.g. more than 3%) the Investment Committee decided to rebalance back to the neutral position.

Conclusion

These are difficult days. First in terms of health, where a danger that we cannot see is keeping us indoors and isolated from each other. Schools, offices and factories are shut down, bringing our social lives and economies to a halt. In no way do we make light of an environment where words such as ‘pandemic’ and ‘recession’ are increasingly heard. We believe, however, that both are temporary. Already, some signs of what looks like stabilisation in infection rates is occurring in China and other regions. Nonetheless, it is difficult to say when the outbreak will lessen and enable economies to start up again, but we expect it to happen later this year. The tremendous amount of monetary and fiscal stimulus will give an added boost. In the meantime, we encourage continued patience regarding your investment portfolio, and suggest making no large moves. We believe that staying put continues to be the best course during periods of market turbulence.

Richard de Groot, Chair, ABN AMRO Investment Committee

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