Investors crave certainty and when we don’t have a conclusive answer on a topic, our natural response is to sit on the sidelines.
COVID-19 raised uncertainty about markets. Few investors saw the March 2020 crash coming, which led to a 35 per cent decline in equity markets. Even fewer saw the recovery that followed.
The lesson during this period is something we have heard all too often – markets are unpredictable, and trying to time markets based on news and headlines does not work.
We don’t like to hear that the future is uncertain, which is why many investors look out for feedback from market commentators about what could happen, this often leads to an attempt at market timing which is rarely successful.
It is important that we understand that there is a limit to how much information we can digest, and once we acknowledge that, we can look at strategies that allow us to generate returns without the need to time markets.
On the other side of the spectrum are investors who are too idle, often not investing whether markets are selling off nor when they are making new highs.
Avoiding markets when they make new highs may feel right intuitively, however, the reality is it often leads to many missed opportunities and significant underperformance. This is because equity markets often continue to make new highs for an extended period of time, and sitting in cash when rates are low can mean a negative return net of inflation.
Knowing what you don’t know
We are still learning the virus, potential mutations and sustainability of immunizations, or how reopening economies play out and how long developing nations struggle with growing cases.
Well known American investor Charlie Munger summed it up nicely: "This thing is different. Everybody talks as if they know what’s going to happen and nobody knows what’s going to happen.”
Economic impact: What we do know
- Global GDP shrank significantly in 2020.
- Certain sectors won’t go back to the way they were for a long time, like travel and tourism dependent sectors – while other sectors such will benefit over the long term.
- Central banks will continue to support economies by any means necessary. The consequence of this is higher deficits and lower currency values.
RBA is likely to keep rates lower for longer
There is no ambiguity about this, Reserve Bank of Australia governor, Philip Lowe, has made it clear that low rates are here to stay, at least until 2024. While negative rates are “highly unlikely” the central bank will continue to use yield curve control as the preferred monetary policy tool. The RBA is not alone in keeping rates low and this is a global phenomenon.
How long have rates traditionally stayed low?
Following the 2008 global financial crisis, central banks also lowered interest rates to stimulate the economy. The US and the European Union kept rates near zero for 8 years, in the case of Japan, rates have been near zero since 1999. If history is any guide, waiting for interest rates to rise may result in years of underperformance.
Five strategies for uncertain markets
- Investing with less directional payoffs: certain investments may allow investors to gain indirect exposure to equity markets while offering an investment margin of safety. These investments can be tailored to modify the risk return payoff of the underlying exposure. A large range of payoffs may be available that offer downside risk management
- Reliable income: Providing the source company does not default, Investments such as corporate bonds and structured notes offer a more sustainable source of income when compared to dividends, which even for blue chip names may be cut or suspended during an economic slowdown. According to S&P’s 2019 Global Ratings annual default transition study, the last investment-grade corporate bond default was in 2016, and prior to that it was 2011.
- Stay cautious and avoid cash: $15 trillion in global stimulus is 17% of global GDP, with even more money printing on its way, coupled with very low interest rates that are here to stay. The impact historically has been higher asset prices and decreasing value of cash
- Absolute return strategies: seek to generate moderate return with lower levels of volatility as compared to non-absolute strategies, and less sensitivity to equity markets compared to other investing strategies
- Diversifying across uncorrelated assets: when creating a resilient portfolio investors need to look at asset classes that have low correlation for example, adding bonds and gold exposure to an equity portfolio can help cushion portfolios if there is a prolonged downturn in equity markets.
Peter is a Senior Investment Specialist with Citi
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