“We may well see more ‘once-in-a-lifetime’ events before this is all over,” wrote Joe Amato at the end of his Perspectives last Monday.
Twelve hours later, for the first time ever, the May WTI oil futures contract went negative, plunging to a head-scratching price of minus $38 per barrel. At the same time, however, the S&P 500 Index was cresting a 26% rally from its March lows. Indeed, on that once-in-a-lifetime day, with oil futures down 320%, Energy sector equities were down only 3.3%.
This reminds us that the extraordinary market dislocations we are seeing at the moment are a function of the huge uncertainty facing investors.
In this environment, we believe it is important to stay on top of changing circumstances and adjust accordingly, but it is equally important not to get sucked into panics or drawn into unsustainable rallies. That’s why we have spent the past three weeks drawing up a range of scenarios for the progress of the COVID-19 crisis, pinning down the details of investment “playbooks” for each one.
We believe this preparation helps investors adapt to uncertainty, anchoring their views while remaining nimble and proactive, rather than reactive.
Did we learn anything from last week’s breakdown in the oil market?
In one sense it was specific to the technicalities of WTI logistics and storage space in Cushing, Oklahoma. But it was also yet another reminder that global economic activity has been shocked to a degree not seen for at least 90 years.
The most visible sign has been the growing ranks of unemployed. In the U.S., a decade’s worth of job creation has been wiped out in one month.
Last week we also saw the first Purchasing Managers’ Index (PMI) estimates covering the period of global lockdown. Unsurprisingly, the service sector data was especially bad, taking indices to previously unimaginable lows: 27.0 in the U.S., 22.8 in Japan, 12.3 in the U.K., 15.9 in Germany, 10.4 in France and 11.7 for the euro zone as a whole.
Before COVID-19, the service sector kept the global economy ticking over as manufacturing struggled to emerge from a cyclical downturn. Their collapse is an example of how the crisis has piled new woes onto a global economy that was just beginning to overcome existing obstacles to growth.
Nowhere is this starker than in the euro zone, where recent years have seen Spain and Portugal get back to work, Greece return to the bond market, Italy start to fix its banking system, and tentative steps toward addressing the single currency’s structural weaknesses.
When the European Council met last week, it agreed on the need for a large Recovery Fund, but left the details unclear on precisely how large it would be and how it would be split between grants and loans. It may take weeks for Europe’s leaders to pin those details down.
That inconclusiveness adds to the general air of uncertainty. Will COVID-19 be a spur to decisive action, or will it threaten the progress that has been made—and even the entire European project?
When we relate our playbook scenarios to things like the crash in oil demand and PMIs, the unemployment spike and crumbling international solidarity, they suggest we are on the path of our current base case or even our bear case.
In our base case, the virus peaks in the U.S. in May or June and subsequent outbreaks are contained as lockdowns are lifted. Unemployment rises through 15% before reverting gradually, and the U.S. economy finishes 2020 6% smaller. In our bear case, the virus takes longer to get under control and reinfections arise before we develop therapeutics or a vaccine. Unemployment reaches 24%, the U.S. economy ends 2020 10% smaller, and growth stalls through the first half of 2021.
In these challenging environments, we think investors can seek returns from high-quality equities, capture yield from investment grade credit, and look to monetize market dislocations and high volatility in private markets and liquid alternatives. In the bear case, alternatives and core government bonds could play a bigger role.
By contrast, in our bull case the virus peaks this month, unemployment rapidly reverts and the U.S. economy ends the year just 3% smaller. In that scenario a portfolio might tilt more toward high yield, emerging markets and value-oriented equities.
On the face of it, the recent rally in equity markets fits with the more bullish outlook. But even as it implies optimism, it also increases the need for caution. The fact is that emerging markets, value and cyclical stocks have not led the rebound. Instead, investors have been paying more for defensive growth or for stocks, such as Netflix, that are likely to benefit from a longer lockdown. In our view, despite the relief rally, market dynamics still fit best with our current base case.
Re-Imposing Some Certainty
You can see our playbook and listen to us discuss its themes in detail here.
For now, two points stand out. The first is about diversification and the second is about preparedness.
Over the coming weeks and months, circumstances could change radically on the back of news out of politics, epidemiology or pharmaceutical research. Against that background, we think it’s important to think about investments that can be resilient in all scenarios—such as quality equity, investment grade credit, and dislocation and volatility plays—and about tilting portfolios rather than betting everything on a single outcome.
Diversification does not mean “setting and forgetting,” however. Drawing up scenarios and their associated asset allocation playbooks can clarify what we would need to see to make us change our base case, and map out where we would move portfolio tilts before that happens.
When traders have to pay to give someone oil and stock markets surge as tens of millions lose their jobs, we believe this can create a framework to re-impose some certainty on a very uncertain world.
In Case You Missed It
- U.S. Existing Home Sales: -8.5% month-on-month SAAR, to 5.27 million units in March
- Flash Japan Purchasing Managers’ Index: -8.4 to 27.8 in April
- Flash Euro Zone Purchasing Managers’ Index: -16.2 to 13.5 in April
- U.S. Initial Jobless Claims: +4.43 million in the week ending April 18
- U.S. New Home Sales: -15.4% month-on-month SAAR to 627,000 units in March
- Japan Consumer Price Index: +0.4% year-over-year in March
- U.S. Durable Goods Orders: -14.4% month-on-month in March (excluding transportation, durable goods orders decreased 0.2%)
What to Watch For
- Monday, April 27:
- Bank of Japan Policy Rate
- Tuesday, April 28:
- U.S. Consumer Confidence
- S&P Case-Shiller Home Price Index
- Wednesday, April 29:
- U.S. 1Q2020 GDP (Preliminary)
- Federal Open Market Committee Meeting
- China Purchasing Managers’ Index
- Thursday, April 30:
- Euro Zone 1Q2020 GDP (Preliminary)
- European Central Bank Policy Meeting
- U.S. Initial Jobless Claims
- U.S. Personal Income & Outlays
- Friday, May 1:
- ISM Manufacturing Index
Statistics on the Current State of the Market – as of April 24, 2020
|S&P 500 Index||-1.3%||9.9%||-11.7%|
|Russell 1000 Index||-1.2%||10.0%||-12.3%|
|Russell 1000 Growth Index||-0.7%||11.8%||-4.0%|
|Russell 1000 Value Index||-1.9%||7.8%||-21.0%|
|Russell 2000 Index||0.3%||7.0%||-25.8%|
|MSCI World Index||-1.4%||7.4%||-15.1%|
|MSCI EAFE Index||-2.0%||2.0%||-21.2%|
|MSCI Emerging Markets Index||-2.4%||3.8%||-20.7%|
|STOXX Europe 600||-1.8%||1.6%||-23.1%|
|FTSE 100 Index||-0.5%||1.3%||-22.9%|
|CSI 300 Index||-1.1%||3.0%||-7.3%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.0%||2.8%|
|Citigroup 10-Year Treasury Index||0.6%||1.0%||12.8%|
|Bloomberg Barclays Municipal Bond Index||-1.0%||-0.5%||-1.1%|
|Bloomberg Barclays US Aggregate Bond Index||0.2%||1.8%||5.0%|
|Bloomberg Barclays Global Aggregate Index||0.0%||1.0%||0.7%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-1.4%||3.3%||-6.9%|
|ICE BofAML U.S. High Yield Index||-2.3%||3.0%||-10.5%|
|ICE BofAML Global High Yield Index||-1.8%||3.4%||-11.2%|
|JP Morgan EMBI Global Diversified Index||-1.6%||0.7%||-12.8%|
|JP Morgan GBI-EM Global Diversified Index||-1.3%||0.9%||-14.5%|
|U.S. Dollar per British Pounds||-1.3%||-0.5%||-6.9%|
|U.S. Dollar per Euro||-0.7%||-1.5%||-3.7%|
|U.S. Dollar per Japanese Yen||0.1%||0.5%||1.2%|
|Real & Alternative Assets|
|Alerian MLP Index||9.9%||34.9%||-42.3%|
|FTSE EPRA/NAREIT North America Index||-5.2%||1.2%||-28.4%|
|FTSE EPRA/NAREIT Global Index||-4.2%||0.6%||-27.9%|
|Bloomberg Commodity Index||-3.0%||-2.6%||-25.3%|
|Gold (NYM $/ozt) Continuous Future||2.2%||8.7%||14.0%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||-32.3%||-17.3%||-72.3%|
Source: FactSet, Neuberger Berman.