From the Dark Days of Spring… to the Brighter Days of Winter
2020 brought about the deepest global recession since World War II.
This reinforced the importance of being active asset allocators with longterm investment mindsets.
STANLIB’s Global Balanced portfolio managers found opportunities in these unusual times.
While the immediate economic outlook remains uncertain, we must share the optimism reflected in risk markets today.
The astonishing volatility disguised by that number did bring with it some important reminders, for us, two in particular. The first is the importance of being active, something we at Columbia Threadneedle Investments believe is vital in both asset allocation and security selection. The other is the need to think – and invest – for the long term. In other words, we must be able to hold our nerve, as there were remarkable profits to be made last year by those brave enough to ‘lean in’ to risk, when others might panic.
Both financial markets, and our expectations, have come a long way since those dark days of spring. And being active when opportunities presented themselves (but always with an eye to the future) proved a successful strategy for investors in the STANLIB Global Balanced portfolios.
From the dark days of spring
Back in March, as countries were essentially shut down to contain the spread of COVID-19, fear and uncertainty permeated the valuation of pretty much every asset class. Investment grade corporate bond yields (Figure 1), for instance, were compensating investors for 50 times the historical rate of defaults, while several equity indices were priced at or close to their book value. We, like most others, marked our expectations sharply lower for economic and corporate earnings growth in 2020.
Yet at the same time, unprecedented global policy stimulus was released into credit and labour markets, dwarfing anything we have seen before in both scale and speed of delivery. It was our view that – although sharp recessions were likely – this would ultimately prove to be a temporary shock, as policymakers committed vast resources to prevent the public health crisis morphing into a deeper structural one.
STANLIB Global Balanced portfolios were presented with a rare opportunity to ‘lean in’ to those markets that had been badly beaten up, but which looked well-positioned to benefit from the extraordinary policy measures, notably global equities and higher-grade corporate credit.
It felt bold explaining to clients in late March – arguably the point of maximum fear – that we were increasing our allocations to risky assets. But we expected investors to be overcompensated for the economic risks ahead – substantial though they were.
The strength of the market recovery that followed brings us back to where we started: the ability to hold your nerve. Those who were not able to think long term and avoid knee-jerk reactions might have missed out on the fleeting opportunity to participate in the strongest month for global equities since 2009.
But just as policymaker interventions dragged risk markets higher, there was huge variation in the post-crash return profile of different asset classes and companies. The ability to be active within asset classes too, was even more important in a year when certain sectors became almost un-investable. It was our expectation that both economies and corporates would emerge from the crisis saddled with higher levels of debt. An overarching theme across assets we held within the Global Balanced portfolios was quality. In equities, for instance, our stock-picking colleagues were seeking companies with strong balance sheets, high free cash flow and healthy returns on capital, well-placed to grow earnings in a sea of companies burdened with financial leverage.
To the brighter days of winter?
COVID-19 case count was rising rapidly in January 2021across the US and Europe, the immediate economic outlook associated with renewed lockdowns darker. Yet risk asset prices have never been higher.
It is worth remembering that stock markets – large, public companies – are only a subset of the economy and, as long-duration assets, equities are forward-looking. So we must be too, and in looking to the future, share the optimism reflected in risk markets today – for three chief reasons.
First, a relatively favourable US election outcome has removed some large tail risks and brought with it some (unanticipated) fiscal reprieve. Second, the number of vaccines with greater-than- expected efficacy creates investment opportunities in more cyclical areas of the world. And last, economic contractions in 2020 have been shallower than previously feared, leaving us – in certain regions – with almost ‘V-shaped’ recovery forecasts. While the immediate economic outlook remains uncertain, these factors have set the foundations for a more sustainable cyclical recovery.
Our most recent moves within the STANLIB Global Balanced portfolios have been to tweak our equity allocations higher once more, this time, with a joint focus on quality companies that also stand to benefit from a cyclical upturn. For instance, Pernod – a high-quality drinks business – should benefit from a re-opening of hotels, bars and restaurants, and Disney (a new holding, bought at a substantial discount) has already seen considerable uptake on its Disney+ subscription service, but the broader business stands to benefit as its parks and cruise lines re-open.
Meanwhile, within the global bond sub-portfolios, we have trimmed our duration overweights. This proved helpful in 2020 as government bond yields found new lows, but the outlook for sovereign duration may be challenged in the recovery scenario we anticipate. Importantly however, our expectations are that there will not be a meaningful rise in bond yields, and those low discount rates remain a powerful support to sustain risk asset valuations.
Volatility will probably continue to dominate markets in 2021, as the world takes on the monumental challenge of a global vaccine roll-out, but to our minds it would be a mistake to make knee-jerk reactions. As active, but long-term investors, we must maintain our strategic positions and continue to look for the winners of this ever-changing world.