Multi-Asset Macro-Economic Update
What’s been happening in markets?
We're seeing quite a large demand shock. SO we are going into this with a massive drop in demand, probably a massive drop in growth. And it’s going to be quite deep, so probably deeper than the GFC, but likely to bounce back faster than the GFC. So a deep, but short recession effectively.
Now what that is, is you are seeing consumer stopping spending. They are not leaving their houses and besides buying toilet paper, they are not exactly consuming as much. So the question is how can governments protect a further downturn? So they are throwing the kitchen sink at this. So if you think what they need to do, it’s ensure a. companies survive, b. people stay employed or when they come out of the recession they have money to spend.
So they are throwing fiscal stimulus at it. We saw the $US to $2 trillion overnight, so that’s a large number, that’s about 8% of GDP. So they’re really hoping that that keeps companies afloat and keeps people employed or cashed up so that they can actually spend when the demand shock eases.
We are also seeing monetary stimulus that helps keep companies open by letting them tap the market. They’ve gone from about $45 billion per month during the GFC to $75 billion in the past two days, so they’ve done quite a lot recently. And they have gone from buying treasuries, to mortgage backed, to buying investment grade credit. So it’s actually quite a big step out to what they are used to doing and they are really throwing everything at this problem.
Now Australia is no different. I don't think Australia can continue to have it’s 28-year expansion. I think we will go into recession, like the rest of the world we can't escape that. Unfortunately we have had some pretty bad hands recently: our biggest trading partner China had a trade war for the past year; then we had bushfires which essentially decimated some of our tourism sector; and now we've closed off borders. So if you think our third and fourth largest export is tourism and foreign education and we’ve closed the borders - that's going to disappear.
Now, Iron Ore etc. they will benefit from the falling dollar Aussie dollar but demand globally has come off. We're in a situation where all those things will come under pressure, we will have a similar shock. Some economists are saying, you could see next quarter GDP fall by 5%, or more than 5%, which is the worst ever. But similarly we’re throwing the kitchen sink at this problem as well. We’ve had $2, to $18, an now $66 billion of stimulus. That's really trying to help cushion that blow, that's around 3.3 % of GDP. So if you have that contraction hopefully we'll have that V shape or U shaped recovery, but we don’t think the worst is over yet.
What’s the outlook from here?
Well what I think we're seeing now is a relief rally over the past couple of days. If you think about it, we've seen one of the fastest falls in US equities (35%), just the past couple of weeks it's been quite a substantial fall. So many people have sold their equities and de-levered, so having a bit of a bounce, especially on those stimulus measures is acceptable. But we're worried about as a W shape recovery in equities, so you could have a bounce, but it might retest its lows. Some of the things we want to pass the bottom is a peaking of case counts. We're seeing what's going to happen to Italy. Can the lockdown in Italy do the same thing as it did in China? It will be the first case of a democracy undertaking a lockdown. If it's successful then that might give markets some hope. We haven’t seen nearly enough cases in the US to see a peak, which is important as it’s one of the major markets. We’re waiting for that peak to come through.
Secondly, earnings - we know prices have fallen but not how much earnings have fallen. We're predicting a 30% drop in EPS, which is quite substantial But again, 35% in equities is kind of in line with that. That doesn't mean equity is cheap. It just means they’ve fallen in line. So, it isn’t a screaming ‘buy right now’, but if we do start to see some of those earnings recovering, we will have more interest in buying back at this point.
What are you doing in your portfolio?
Well we were quite lucky coming into this because we didn't foresee a virus, but we knew that equity markets were expensive and vulnerable to shocks, so we came into this with low equity weights and a large duration allocation, which does well in times of market stress.
When the crisis first hits, we actually sold more equity for more duration. And we actually had quite a lot of US dollar exposure. So, when you have a liquidity crisis, which we eventually did after the virus, you saw a flooding into US dollars, margin calls etc. that pushed the US dollar up quite substantially versus the Aussie dollar. Having that in the portfolio was helpful. And we've also been adding to duration. So that's what helped cushion us from the fall.
Now at this level, we don't know if the bottom is in, we don't think the bottom is in, but at this point, with the three-year horizon, there's some quality assets to pick up. So, we have added a bit back to equities. We've also been looking at credit markets, depending where you're looking, some default rates are actually pricing in a depression, which is not our base case. So, if we can find some high-quality issuers yielding around 8%, then we’ll take that opportunity. We have been dialling up our allocation and things like that and credit.
We've also taken advantage of the volatility. We sold some put options, so it actually gives you about an 8% premium. And the worst-case scenario is you buy equities at the level you want to buy at the price you want to buy. So, we think that’s a good chance to get that premium in. We're slowly allocating to risk on a medium-term view, but we're not diving in full swing at this point. We remain cautious, but are finding high quality opportunities for the next three years.
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