Repositioning Your Portfolios Amid Crisis: CIO Insights on Shorter- and Longer-Term Opportunities
Traditional Valuation Metrics Could Be Misleading at This Point
- Because the coronavirus crisis stems from medical and social factors, there is no historical analog, says John Linehan, Chief Investment Officer (CIO), Equity Division.
- A high level of uncertainty and a lack of company guidance make it difficult to forecast earnings or revenues with any sort of clarity, Linehan adds.
- Interpreting credit spreads in fixed income sectors is especially difficult given the enormous dispersion in different industries, says Mark Vaselkiv, CIO, Fixed Income.
The Crisis Could Structurally Change Risk Premiums, Especially in the Energy Sector
- The energy sector appears to have the highest potential for a reset of risk premiums, given the pain investors have experienced, Linehan and Vaselkiv say.
- Aerospace and travel also appear likely to be penalized with higher risk premiums, Linehan adds. However, some growth stocks could benefit from structural changes.
- Recent years have seen a compression in the yield premium for potential illiquidity in the high yield market, Vaselkiv notes. The crisis could cause a reversion.
Investors Have Grown More Discriminating, but Active Return Opportunities Can Still Be Found
- Primary markets have reopened for both high yield and investment grade (IG) credits, and there is investor demand for bonds that are attractively priced, Vaselkiv says.
- Stock correlations have declined since their March peak but remain high, Linehan notes. In part, this reflects structural changes, such as the growth of exchange traded funds.
- Many investors remain focused on short-term risks, creating opportunities for active managers to focus on companies where they have confidence in the core fundamentals
The Sustainability of any Market Rally Will Be Decided on Main Street, not Wall Street.
- Although fiscal and monetary stimulus are helping the largest U.S. companies, Vaselkiv says he worries about the recovery prospects for small- and medium-sized businesses.
- The equity rebound appears to reflect expectations that a coronavirus vaccine or other effective controls will be developed in the short- to intermediate term, Linehan says.
- The potential range of outcomes for the coronavirus crisis is significant, Linehan adds, noting that the 1918 flu pandemic saw a significant second wave of infections.
Opportunities Can Be Found in Corporate Credit and in Selected Value Sectors
- The abrupt shift from a buyers’ market to a sellers’ market has disciplined the primary high yield market, Vaselkiv says, improving prices and terms for new issues.
- Credit downgrades have moved a number of formerly IG-rated companies into the high-yield universe, improving overall credit quality in the latter space, Vaselkiv adds.
- Investors have overreacted to the threat the crisis poses for utility companies, which operate in regulated markets, Linehan says. This has created mispricing opportunities.
- The dramatic decline in oil prices may set the stage for a rebound as demand comes back on line and higher-cost supply is forced out of the market, Linehan says.
- Economic uncertainty and credit exposure remain significant risks for the financials sector, Linehan notes, but markets may be overestimating the payouts that property and casualty insurers will need to make as a result of the crisis.
- Overall, the value style is likely to remain challenged as investors focus on growth companies that appear poised to benefit from structural change, Linehan says.
Investors Need to Be Thoughtful about Risk and Pay Attention to Bottom-Up Fundamentals
- Investors need to recognize that the range of potential market outcomes is still extremely wide and need to be thoughtful about the risks they take, Linehan says.
- In addition to looking at the potential impact of the crisis on the broad equity market or on specific sectors and industries, it’s also important to assess risk on a bottom-up, stock-by-stock basis, Linehan adds.
- With yields at or near record lows, a medical breakthrough and/or reopening of the U.S. economy could put significant downward pressure on Treasury prices, Vaselkiv warns.
- Equity and fixed income markets are likely to remain volatile through the rest of 2020 and 2021, and perhaps into 2022 as well, Vaselkiv cautions. Maintaining a disciplined long-term approach will be critical.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of May 7, 2020 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.
T. Rowe Price Investment Services, Inc. Distributor