As you will have noticed, there’s been a significant sell off in risk assets with S&P down 8%, European equities down 7%, FTSE 100 down 5% and TOPIX down 4%. We’ve also seen the US yield curve inverting and 10 year US treasuries’ yields falling to c.1.3% (a record low) as concerns around the spread of Coronavirus prompted a flight to safety. Inevitably you will be wondering how this has been impacting your portfolios: the latest data shows that for MyFolio risk level III across Market, Managed and Multi-Manager they are down between 2.7% and 3.5%, or roughly between 40% to 50% the fall of global equities.
So what is our house view? Just prior to the virus outbreak our macro momentum indicators had moved into expansionary territory (59% relative to a threshold of 50%) and data was suggesting that the probability of a US recession within the next 12 and 24 months was contained.
What do we expect will be the impact on corporate profits? We’re seeing downward revisions to H1 earnings and analyst consensus is that global EPS’ should be revised downwards. We see similar theme when we look at S&P 500 short-term earnings growth expectations; they have reduced significantly.
Our internal growth projections suggest that while there may be a significant impact to markets and to GDP growth over the short term, we do expect a fairly speedy recovery once we begin to see evidence that the virus is more contained.
Might we see central banks intervene by easing conditions further? Possibly, there is at least scope for more monetary easing. If we look at developed market interest rates our forecasts are that interest rates are either maintained at current levels or lowered. When we look at the emerging markets we see more opportunity to ease than in the developed markets.
So what’s priced in? Relative strength indicators suggest global equity markets have oversold. The chart on the right highlights that significant market sell offs tend to be short lived in the absence of a recessionary environment.
So what are we doing? We’ve decided to increase the portfolios’ allocation to equities, taking advantage of the sell-off. We will do this by increasing exposure to UK equities (+25bps [to +50bp overweight]) and to US equities (+25bps [to 25bps overweight]), both of which will be funded from cash.
TAA additional rational
UK equities have been the epicentre of the storm as a combination of undesirable exposures led to a sell-off including high exposure to EM combined with commodities/oil dependence. UK equities offer an attractive and reliable dividend yield (4.8%, very attractive in such a low yield and low growth environment). UK equities also look attractive on other valuation metrics; P/E has seen a consistent de-rating vs rest of world since Brexit referendum.
We’ve initiated a modest overweight position to US equities on the basis that we view it as a quality market with defensive characteristics which should complement our more cyclical equity exposures such as Japanese and EM equities. US equities may not appear cheap on traditional measures but offer great cash returns to shareholders due to their robust profit generation. The combined dividend and buyback yield of S&P 500 exceeds 4% which compares favourably to yields on many fixed income instruments. US companies tend to be global profitability leaders and despite a pause in EPS growth last year we expect earnings to pick up in the second half of this year.