What are the ways to strategise portfolio allocation in today’s market environment?
The world economy is in the midst of a sudden stop where activity has been brought to a halt by official action and lockdown of borders and cities to suppress the coronavirus. Against this backdrop, we have revised our forecasts lower as we see a recession in global GDP this year with the downturn concentrated in the second quarter.
Sentiment remains fragile amid mixed fundamentals
On a positive note, loose monetary and fiscal policy should remain supportive, with the announcement of unlimited QE from the Fed and stimulus package from ECB. There are also signs of stabilisation in new cases in Europe and US, where we may see some easing in lockdowns and resumption of economic activities. However, sentiment remains fragile and sensitive to headlines and geopolitical risks both in the Middle East with falling energy price, and between US and China on tension due to the Covid-19 outbreak and trade tariffs.
Impact on dividend may vary across sectors
Investors will still need more data and evidence to assess the impact on corporate earnings as companies have started reporting Q1 results. Given the pressure on margins, we anticipate dividend cuts or more conservative payouts from companies, although the impact should vary across sectors. With interest rates being cut dramatically to support growth, and credit risks increasing as economies enter recession, bank earnings are likely to be under pressure, both structurally and cyclically.
The Monetary Authority of Singapore (MAS) recently announced easing measures for REITs to delay their income distribution of the current quarter to later in the financial year of 2020, which would give more flexibility in raising funds and managing cash flows, although it also increases uncertainty on dividend payments on the other hand.
Dividends from telecom and utilities should also be more resilient compared to other sectors such as financials which face strong headwinds following the recent announcement by a number of regulators to advise banks to halt dividend payments.
Gradual addition of exposures within defensive portfolios
With the re-opening of the Chinese economy, we expect a recovery in earnings and sentiment, while additional government easing via both fiscal and monetary policies are also supportive. That said, we feel that we can take time in building up China exposure, considering the risk of a secondary impact on its economy due to reduced foreign demands which could hurt export and consumptions. The tension between US and China also adds to the uncertainty.
One way to add some risk back to portfolios would be via credit as the dislocation triggered by liquidity concerns has been abating given the pledge of support by global central banks. Specifically, the US Federal Reserve has announced programs that would allow the central bank to purchase both investment grade and recently downgraded high yield (aka “fallen angels”) corporate debt. This large-scale stimulus has resulted in strong tightening of spreads in US credit, but we have yet to see the same degree of tightening in Asia. With stronger fundamentals and more attractive valuation, we believe that the large amount of liquidity in developed markets could result in spill-over support into Asian and EM credit.
In general, we remain relatively defensive with a preference for investment grade over high yield and more defensive non-cyclical sectors.
Pockets of opportunities in high quality names
Compared with REITs and banks, we favor areas such as materials and technology where we see more attractive opportunities to capture income and growth. We can find interesting tech plays in Korea. Our view is that the tech cycle and consumer demand could rebound once the virus situation improves from here. On a relative basis, the dividend yield of 3% to 4% and further growth in the future also looks more attractive in the zero-interest-rate environment and against the expectation of falling dividends in other sectors.
Notwithstanding the near-term shock on commodity demand, we believe investors will start to rotate back into cyclicals to play the recovery. Liquidity conditions in the corporate credit space has improved due to the unprecedented stimulus package from the Fed and global policy makers. Overall valuation in the credit market now looks fair, yet we still see pockets of opportunities by acquiring high quality names.
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