Johanna Kyrklund: You don’t know what you’ve got ‘til it’s gone

When people ask me how I’m faring through these volatile markets, I always tell them that in many ways it feels much like the previous turbulent periods I’ve seen in my career.

Like today, the causes of such markets are typically without precedent, be it the emerging market crises of the 1990s, the end of the dotcom bubble in 2000, the Enron scandal in 2002, the Global Financial Crisis in 2008, or the European sovereign debt crisis.

Investing over these past 23 years has never felt easy. The future is always uncertain and risks are always around the corner. But there was always one thing you could rely on and its absence makes things a lot more difficult: the comfort of bonds and cash.

As you can see in the chart below, in previous crises if you wanted to be defensive, you could park yourself in government bonds yielding as much as 8.8%, or even cash at as much as 7%. 

Cash over the last 10 years has become far less kind to investors, with yields in many cases moving into negative territory. But you could at least still get some yield from government bonds, plus they had a nice negative correlation with shares (i.e. the price of bonds would rise when equities fell and vice versa).

Sometimes you don’t know what you’ve got ‘til it’s gone. 

At the time of writing (19 May), the US 10-year Treasury yields 0.7%. And our analysis suggests that over the next three years, it’s by no means certain that the negative correlation between bonds and equities will reassert itself.

"Safe haven" US Treasuries yield far less than in previous crises

Source: Bloomberg and Schroders, as at 14 May 2020.

We think the Covid-19 crisis will have a deflationary impact, but with government bond yields at current limits, they are less able to provide protection for portfolios. Further out, we are also concerned that higher government debt levels could reduce the attractiveness of bonds as a hedge in portfolios.

Lockdowns are being eased, which may lead to a short-term bounce in economic data. However, looking six-to-12 months down the line, I remain concerned about the economic outlook.

Without a medical breakthrough, subdued economic activity is the only way to contain the virus. The longer this drags on, the more likely we are to see second order impacts on businesses and employment.  

With this in mind, I would still be cautious about assets most exposed to the economic cycle. I would favour investment grade corporate bonds, which can benefit from the liquidity being provided by governments and central banks.