Asset Allocation in Times of Volatility

The COVID-19 pandemic has redefined global markets and raised important questions about asset allocation in investment portfolios. In this post we update our views on the economy and the policy response and tie it back to our portfolio strategy going forward.

Markets During This Drawdown

After a strong start to 2020, markets reacted quickly and severely in mid-February when the global spread of the COVID-19 virus became more apparent. An almost 11-year bull run changed into a bear market in a matter of days. Bond markets have witnesses significant dislocation and liquidity issues. Canada has been hit particularly hard during the crisis, with the economic fallout coinciding with an oil price war instigated by Saudi Arabia and Russia, devastating the Canadian oil and gas sector.

Downturn Duration and Policy Response

At this point a global recession is baked in the cake—the question is how deep and how long the downturn will be. Our concern is that the containment measures will need to last longer, and the recovery will be a bit shallower than many presume given the virus appears to still be accelerating.

However, this downside risk to the economy is offset somewhat by the massive monetary and fiscal policy response. The FED and other central banks have been extremely aggressive in order to maintain market function in the face of the unprecedent stop to the economy. Although 0% interest rates and vast amounts of quantitative easing will not get people out to restaurants any time soon, it does support the financial system and lays the groundwork for some animal spirits when we come out the other side of this crisis.

Fiscal policy has been a bit slower and messier to get across the line but is coming through with some vigour and they aren’t done yet! Governments are looking to back-stop companies, small business and individuals to get them over the hump to try and protect jobs/incomes and keep viable businesses alive.

As the economic negatives compete with the fiscal and monetary positives it leaves markets in a volatile state. Our view is there is some risk to a longer drawn out recovery. Even if the virus is contained sooner than later, the economic rebound may take some time as individuals and businesses are slow to return to ‘normal’.

Portfolio Positioning

Going into the downturn we have been positioned more defensively with lower equity exposure and a slightly more defensive posture generally. Growth had been decelerating and valuations in equity and credit seemed a little stretch. We maintained the view that there would be a better level to add risk at some point which is now materializing.

Given the uncertainty and risk to the downside on the virus and economic front we are reluctant to add too much risk to the portfolios right now. We have chipped away and increased equity exposure to a slight overweight on recent weakness. The credit markets carry more risk, but we are starting to see some opportunities there as credit spreads have shot up and thus we have been marginally increasing some higher quality credit exposure.

The outlook for stocks is more attractive compared to bonds over the a longer 12–18 months time horizon as equity valuations are resetting and the low level of government bonds yields suggest lower forward return potential from that asset class. Central banks and governments have been united on the need for fiscal and monetary stimulus which should ultimately allow for easy liquidity to help spur a recovery in the wider economy. As the table below suggests, this should translate to better market returns coming out the other side. Still, our concern is we will see lower equity prices before a more sustainable recovery materializes hence our suggestion to proceed with caution and patience in adding risk to portfolios.

The current duration of the bear market is almost 2 months and the bear decline is approximately -26%.

Michael Greenberg’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.