Investing in COVID-19 outbreak Seizing opportunities in a turbulent environment

Post COVID-19 economic reopening is unlikely to be smooth. UBS Asset Management investment experts discuss the current market environment, and the risks and opportunities they see over the next quarters. 

28 Apr 2020

Investing in COVID-19 outbreak

Seizing opportunities in a turbulent environment

The COVID-19 crisis has disrupted equity and fixed income markets, and economic re-opening is unlikely to be smooth. At our second-quarter Quarterly Investment Forum, portfolio managers across asset classes shared their best ideas for finding opportunities in current volatile markets.

Investing in COVID-19 outbreak

Investment outlook and asset allocation

Evan Brown, Head of Multi-Asset Strategy

The COVID-19 pandemic and associated lockdowns are causing what will likely be the deepest recession since the Great Depression. Still, this recession will probably also be one of the shortest in history, due to the extraordinarily fast and powerful policy response in the US and globally. The Fed has gone from monetary policy to outright credit policy, touching many areas of credit flow into the economy and introducing facilities well beyond those in 2008.  Globally, the speed and scale of fiscal stimulus has dwarfed that provided during 2008/2009. And unlike the period following the financial crisis, we do not expect fiscal retrenchment given the populist pressures facing many governments. 

COVID-19 vs. Global Financial Crisis – deeper contraction but faster recovery

When the world was heading into the Global Financial Crisis in 2007, households and financial institutions were extremely overlevered. And after the financial crisis, they had an ongoing need to de-lever, which slowed the recovery. The COVID-19 recession has been a much deeper initial shock than in 2008, but overall imbalances heading into the crisis were much lower than prior to the GFC. This time it's more of an income shock than a balance sheet recession and there is less retrenchment to do, which means we should have a healthier recovery as the economy reopens.

There is, however, a lot of uncertainty around when and how we reopen economies, and there are clearly big differences across countries. Other questions are whether and when consumers and businesses will feel psychologically safe enough to return to semi-normal activities, and when they do so can we successfully contain renewed outbreaks of the disease.

Our base case for economic reopening

To genuinely reopen, economies will likely require widely available testing — of the virus and also of the antibodies to see if individuals are immune. Countries may also need contact tracing and surveillance systems so that new waves can be identified quickly. We suspect such capabilities will take at least another month in the US and many other developed economies. We expect to see a gradual, staggered reopening of different areas of the economy over the course of late spring and summer.

A big question is whether we experience second waves of infections, which we've seen happen as some Asian countries, Singapore for example, try to reopen. It seems likely that we will have various waves of the virus which may lead to a start/stop period reopening. Reopening is not a linear process. Antivirals like Remdesivir may help reduce the risk of dying from the disease but they are not preventative. Public health officials expect it will take at least another year for a vaccine to become widely available, which is what is needed for full normalization of economic activity.  We will continue to need aggressive government support to provide a bridge in the meantime.

Asset allocation during the pandemic

As we look at how to think about asset allocation between countries, we've collected data on various countries' relative resilience and vulnerability amid the COVID-19 pandemic.

We have looked at demographics, medical capacity, sensitivity to global trade, governance, fiscal response, and lockdown effectiveness. In developed markets, Germany and Switzerland are near the top of the list. Spain, Italy and Sweden show the greatest vulnerability. In emerging markets (EM), north Asia is most resilient, including South Korea, Taiwan, and Mainland China, while South Africa and Turkey are most vulnerable.

Trades for the current environment

Given this framework, we prefer to overweight Korea, Hong Kong and China equities vs. other EM. We take a similar approach in fixed income, where we find Asian high yield attractive relative to other emerging market debt. In currencies, we are long the safe haven JPY vs. USD given the still shaky global growth environment.  And given extremely accommodative monetary policy and widening budget deficits, we have an overweight to gold.

Investing in COVID-19 outbreak

A closer look at active equities

Joe Elegante, Senior Portfolio Manager – Global Intrinsic Value Equities and Global Sustainable Equities

The current stock market drawdown and volatility creates an opportunity set for stock pickers. In order to look at where these opportunities may be, we start by separating stocks into three distinct cohorts. 

Investing in COVID-19 outbreak

The case for global fixed income

Jonathan Gregory, Head of Fixed Income UK, Senior Portfolio Manager

The three trades for global fixed income are:

  1. Buy what central banks are buying
  2. Quality high yield
  3. China's bonds as they are a  safe haven

Investing in COVID-19 outbreak

Global real estate is a lagging asset class

Matthew Johnson, Head of Real Estate US, Real Estate & Private Markets

Private market real estate pricing hasn't moved much yet, but the threat of reduced rent collections/top-line revenue resulting from a prolonged nationwide shelter-in-place order could cause operating deficits and mortgage delinquencies (beyond any initial forbearance lenders may provide).  Senior mortgage financing may retract from traditional leverage levels. 

Investing in COVID-19 outbreak

Securitized credit will need a careful approach

Joseph Sciortino, Head of Credit Investments, UBS Hedge Fund Solutions 

Coming into the COVID-19 crisis, the collateralized loan obligation (CLO) replaces housing and consumer loans which were the over-levered asset classes during the Global Financial Crisis. This has been fueled by the growth of the CLO market which has accounted for 70% of primary issuance of levered loans over the past two years. The growth of the single-B and below market has had a really dramatic impact on the overall quality of the loan market. The default rate in past cycles for that level is significantly higher. So you see the big jump in default rate that the distribution is much higher and the actual size of the loan market is significant.

Investing in COVID-19 outbreak

The Fed has created a floor for investment grade spreads

Casey Talbot, Head of Fixed Income, O'Connor 

The goal of the US Fed’s programs announced on March 23 was to quickly inject liquidity into a market that was overwhelmed by sellers due to redemptions/liquidations without a ballast of market makers or buyers. The Fed unveiled several facilities from the Global Financial Crisis period  (PDCF, TALF, MMMLF, FX swap lines)  along with a few new seminal programs to also address the CP, Muni, and credit markets.

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