Asset Allocation Viewpoints
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- We moderated our equity overweight, taking the opportunity to capitalize on gains as the market rebounded into a bull market at an unprecedented pace off lows reached in late March.
- Within our regional equity positioning we moved to neutral U.S. equities from an underweight. The U.S. market’s profile is more defensive—with heavier weights to technology and communications—and its economy may be better positioned to support a rebound in growth buoyed by unprecedented fiscal and monetary stimulus.
- Within the U.S., we moderated our overweight to small-cap stocks. Despite still attractive relative valuations, smaller companies are likely to face near-term headwinds given their broadly higher exposure to consumer spending and more limited balance sheet flexibility relative to larger companies.
- Outside the U.S., we moderated our exposure to more cyclically exposed value stocks as economic growth is likely to remain challenged. We also pared emerging markets exposure as many countries, other than better-resourced economies like China, face challenges containing the coronavirus outbreak and have limited tools to support growth.
Trying to put a price on the stock market in the current environment is extremely challenging. The velocity of the market decline and subsequent recovery are unparalleled, with day-to-day price swings that can look more like returns for a full year. Similar to the “P”, in price-to-earnings measures, the “E” is challenging to pin down as estimating earnings is hampered by uncertainty around the duration of the global shutdown and the post-crisis environment. First quarter earnings reports are starting to shed some light, and the broad picture shows a steep decline with S&P 500 earnings down nearly 15%. In this environment, there have been winners and losers, with technology and communications sectors resilient, while other more cyclical sectors have been hard hit, including energy and industrials. Compared with previous crises, today’s crisis is not normal and the speed of the recovery may not be normal either. What may be very different, though, are the winners and losers, making it ever more important to watch what you’re paying for “normalized” earnings for companies that will likely be facing an abnormal world.
Fed Extinguishing Liquidity Risk, Solvency Smolders
Global central bankers have unleashed unprecedented monetary policies to help offset contracting growth and ease widespread liquidity strains. In the U.S., the Federal Reserve has launched several lending and asset purchase programs that have provided much needed stability within the commercial paper, U.S. Treasury debt, corporate bond, municipal bond, mortgage-backed, and money market sectors. The most direct support will come through the launch of the Main Street Lending Program under which the Fed is directly providing loans through its network of banks to small and mid-size businesses that are too large to participate in the Treasury’s Paycheck Protection Program (PPP). However, these loans will need to be paid back, whereas the PPP lending converts to grants if used directly to fund employee wages. While these actions by the Fed provide much needed liquidity, eventually these businesses must be able to stand on their own. Given the uncertain future for many industries post-crisis, markets are likely to shift their focus to solvency risk, where some companies’ profitability may not be able to sustain their debt obligations.
First quarter gross domestic product (GDP) growth rates around the world are showing levels of contraction not seen since 2008, with the U.S. slipping -1.2% quarter over quarter (-4.8% on an annualized basis) and the eurozone down -3.3%. The steep declines were largely due to the extensive lockdown measures implemented worldwide, which hampered the previously resilient consumer and severely impacted services industries such as entertainment, health care, and food. As bad as these first quarter numbers were, the data only reflected economic closures that started around the second week of March, indicating that next quarter’s data will be much worse, with nearly the entire economy impacted by lockdowns in April and significant portions of May. Despite the alarming economic growth, unemployment, and manufacturing data, global stock markets have shrugged off the weakness as temporary in hopes that recovery will not be too far off once economies reopen. With a headline second quarter GDP number in the U.S. that could be as low as -40%, we’ll see if markets will continue to look through the negative data or begin to react in a different direction.
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