The sharp sell-off in equity markets might mean that investors are holding more bonds in their portfolios than they are comfortable with, according to BlackRock’s Mike Pyle, but they shouldn’t be too quick to top-up their equity allocations.
The seriousness and rapid spread of the coronavirus Covid-19 outbreak has had a significant impact on equity markets, which had been riding more bullish sentiment as 2020 began.
As the below chart shows, equity markets have slumped since the start of the year, with the FTSE All Share down by 23.38 per cent, while bond markets have been less severely impacted.
Performance of indices YTD
Source: FE Analytics
“The coronavirus outbreak represents a major external shock to the macro outlook, akin to a large-scale natural disaster,” said Pyle, BlackRock’s global chief investment strategist.
“Public health measures deployed to stop the virus’ spread are set to bring economic activity to a near standstill and cause a sharp contraction in economic growth in the second quarter.”
And while the strategist expects activity in markets to return with “limited permanent damage” it is contingent on the “overwhelming” policy response to bridge businesses and households through the shock.
Indeed, writing in August 2019, the BlackRock Investment Institute had warned that “unprecedented policies will be needed to respond to next economic downturn” when it happened.
“Monetary policy is almost exhausted as global interest rates plunge towards zero or below,” it noted at the time.
Now that coronavirus has hit there has certainly been ‘unprecedented’ action by authorities and central banks around the world. However, the impact has already been felt by investors.
Although investors typically rebalance portfolios towards strategic allocations on a calendar basis, said Pyle, the speed and sharpness of the equity sell-off might have some wondering what to do now.
Pyle said investors following a traditional 60-40 asset allocation strategy – 60 per cent equities and 40 per cent bonds – would have seen the weight of equities rapidly shrink to just over 50 per cent in recent weeks.
Source: BlackRock
The BlackRock strategist said the one-month drift seen in markets recently (as shown above) was sharper than that seen during the 20008 global financial crisis.
Despite the sell-off, Pyle said, benchmark weights remain appropriate but it may be too soon to move portfolios back to an equities overweight.
“As we await signs coronavirus infections are peaking and decisive policy actions are stabilising the economy and markets, it may be prudent to start leaning against market moves through rebalancing,” he said.
“The right time to do so will vary by investor and should take into account considerations such as transaction costs and market liquidity.”
As such, Pyle said the asset management house it has maintained its neutral positions on equities, credit, government bonds and cash. Although there have been some changes at a geographical level for the next six-to-12 months.
Pyle said it favours geographies – for both equities and credit – with the most space for enacting fiscal and monetary policies to help stimulate economies ahead of any anticipated slowdown in growth.
These include the US and China, with the former announcing a $2trn support for the domestic economy and has begun to coordinate its response with other developed markets.
In addition, Pyle said BlackRock has upgraded its outlook for US equities because of their quality bias and support from the government.
The outlook for Asia ex-Japan equities has also been upgraded on the prospects of an “eventual growth uptick”.
“We see China as in the early stages of restarting its economy and having more policy space to revive activity,” he added.
Not all Asian markets are popular, however, with the asset manager downgrading Japanese equities because of the lack of space for authorities there to enact fresh monetary and fiscal policies to offset the outbreak’s impact.
Meanwhile, European equities remain an underweight position based on their dependence on foreign trade and as they are at the epicentre of the virus outbreak.
The coronavirus impact is a concern for emerging markets too and they have been reduced to a neutral weight from overweight due to the global slowdown and oil price war.
Looking at fixed income, the strategist said it reduced treasury inflation-protected securities (TIPS) to neutral after the Federal Reserve cut rates to near zero, “though we still see value in the long term”.
In addition, the asset manager has upgraded peripheral eurozone government bonds to neutral after recent spread-widening and an expectation that measures by the European Central Bank will keep yields low in southern-tier countries.
Meanwhile, its cash positioning stance remains neutral for risk mitigation purposes.
Nevertheless, the recent fall in equity prices has created ‘significant value’ in risk assets, albeit tempered with a warning.
“We believe market volatility is distracting from the sheer amount of stimulus being put in place – and there is more to come,” Pyle concluded.