Updated: Apr 10, 2020
There's a tremendous amount of disruption in the markets as a result of the COVID-19 crisis. This has been so profound that many seasoned money managers are at a loss for words, let alone a cogent asset allocation strategy. The big question is what strategy makes sense in this market? The short answer is given unprecedented uncertainty and data still rolling in, there's no "one size fits all" approach. “Wait and see“ isn’t of much value either, so this is our current thinking:
In terms of public markets, we believe that there remain a number of potential issues that can at any time trigger a retesting of the lows that we saw in recent weeks. Among those issues are:
1- the full impact of the economic shutdown is not understood. Many companies will not survive the shutdown even with the CARES bill assistance.
2 - 70% of GDP is consumer-driven. With record jobless claims, corporate earnings will be way off original forecasts.
3 - Both consumer and commercial credit will face unprecedented default levels. Credit will become tighter (it already is), and many businesses will be unable to borrow.
4 - Any reemergence of the COVID-19 virus or evidence of a failure of containment will require extension or restart of social distancing protocols. Reemergence in the absence of a vaccine is actually a likely scenario.
All are reasons to exercise extreme caution in the public markets. The only certainty we see is that there will be ample volatility. So for those able to effectively deploy volatility-based strategies, there is an opportunity. Trading volatility, however, should be left to professional traders.
We caution against the view that there will be a near term “v-curve bounce” and return to a bull market. We have entered a new highly unstable economic period and risk factors point to a long slow recovery accented by profound purchasing power erosion and periodic extreme volatility. Accumulating recession-resistant buys makes sense under certain limited circumstances. However, we believe there could be a retesting of market lows again before the end of the year.
In terms of credit markets, we emphasize the same degree of caution until credit ratings are re-evaluated in light of recent economic changes. Corporate yield spreads have increased well over 300 bps and the leveraged corporate loan market is still highly illiquid with price discovery underway.
In terms of asset allocation, a key risk is holding non-inflation hedged assets while the money supply is being inflated significantly. US dollar purchasing power will continue to erode due to the rapid increase in government debt. The $2.3T CARES bill, though necessary as an economic lifeline, is far from a stimulus package. More debt will be issued this year which will erode purchasing power. All governments now have the same problem, so all fiat currencies face varying levels of inevitable purchasing power erosion.
The near term (>3mos to 1yr) liquid portion of holdings should have a significant gold bias in the form of gold ETFs and physical gold. Bitcoin, though more volatile than gold also provides some insulation to purchasing power erosion. Bitcoin, for example, is up 39% YOY. More government debt issuance is coming and USD purchasing power will be eroded further.
In terms of private equity, there are and will continue to be unprecedented values in certain private investments. Where prior to COVID-19 it was a seller's market with valuations well over 10X EBITDA, today there are "generational buying opportunities" that haven't been available for over a decade. For family offices with the ability to invest conservatively (e.g. low to no debt) and for the long term, this is an amazing time to put money to work in certain industries.
Private equity transactions have picked up to a frantic pace as investors that have been sitting on cash look for values. It's early days, and as businesses come under additional financial stress, they will trade at even more competitive values.
From a policy perspective, it is important that state and federal governments sponsor economy building investments in energy, communications, and transportation infrastructure. These types of government investments create jobs and corporate revenue opportunities. In addition, they have a multiplier effect from the perspective that they improve business capabilities and efficiency while increasing government revenue.
We will be publishing a complete position paper on the winners and losers of the COVID-19 crisis, and strategies for the post COVID economy for registered users on the Insight blog. If you like this content, register and you'll receive regular updates when new posts become available. In the meantime, if you'd like to arrange a conference to discuss your asset management needs, feel free to contact us at firstname.lastname@example.org.
Stay safe everyone!
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Disclaimer- None of the aforementioned should be considered investment advice to the public. These are opinions and should not be considered or acted upon without first consulting the advice of a registered investment advisor.