Weekly Market Compass 2025 investment outlook: After the landing
We expect significant monetary policy easing to push global growth higher in 2025, fostering an attractive environment for risk assets as central banks achieve a “soft landing.”
In last week’s blog, members of Invesco’s Global Market Strategy (GMS) team in Hong Kong, Italy, London, Tokyo and New York shared their on-the-ground insights of the fight against coronavirus from a health care, monetary, and fiscal perspective. Today, we take a deeper dive into the potential implications of the pandemic on US stocks and bonds, as well as the GMS team’s view of asset allocation considerations.
Talley Léger (New York): In a challenging market environment like this, I believe investors should employ technical analysis, which can help inform timing decisions around major market turning points long before the economic data does. Indeed, the stock market must bottom before a new business cycle can begin. Here’s a comprehensive list of tactical indicators that offer an optimistic view that we may be near a market bottom:
Putting it all together, near-term chaos can create long-term opportunities for patient investors. We’re starting to see the kind of despair that kills old bull markets and gives birth to new ones. To be clear, bottoming is a process, but indications of excessive caution in the marketplace suggest savvy investors should start looking for opportunities to be contrarian when others are fearful.
Tim Horsburgh (New York): US fixed income assets staged a marked reversal last week by rallying after an almost unprecedented decline in prices during the first three weeks of March. The Federal Reserve’s forceful intervention on March 23 — with essentially open-ended quantitative easing and a raft of programs to help support various markets — has gone a long way to ease fears of a breakdown in market functioning. Similarly, while more targeted to end consumers to mitigate a demand shock, the fiscal stimulus signed by President Donald Trump on March 27 has also helped ease fears that the sudden stop in many economic activities would prove calamitous for even healthy and well-funded credits. Bid/ask spreads have tightened and, importantly, new deals are transactions are still getting completed.
We believe the recent dislocation has opened opportunities for investors seeking attractive entry points in fixed income. While an economic recession seems almost assured at this point, bonds won’t suffer equally. The Fed’s support will not be able to prevent genuinely distressed credits and companies from going bankrupt. We still favor looking higher in the quality spectrum for some of the best potential reward at this point in the cycle.
Even though spreads likely peaked last week for investment grade bonds, in our view, highly rated credit still looks attractive because it will likely be better able to withstand the coming wave of defaults and bankruptcies associated with even a moderate recession. High quality municipal bonds may also offer opportunities given still-high spreads over Treasuries. Municipal bonds have also historically defaulted at lower levels than many corporate bonds of similar quality. We expect mortgage-backed securities and structured credit to also do well as spreads tighten. The Fed’s decision to intervene in some form in all of these markets should also add an additional tailwind to performance.
High yield bonds, on the other hand, will likely prove more challenging for investors. With the asset class (represented by the Bloomberg Barclays High Yield Index) having an approximately 10% weight to energy3 and generally lower quality balance sheets, there will likely be more price declines and defaults in the future as the recession takes hold. Valuations in high yield are starting to look attractive from a historical standpoint, but with fundamentals deteriorating, it will take time before high yield defaults peak.
While dislocations are likely to persist for some time in the fixed income market, the worst is likely behind us in terms of liquidity fears now that the Fed has stepped in. We believe investors should consider adding to high quality fixed income to potentially take advantage of above-average spreads and solid fundamentals.
Paul Jackson (London): We are living in a world of extreme uncertainty. Assessing the financial market implications of a partial or total economic shutdown in a range of important economies is virtually impossible. Given the unprecedented circumstances, the best we can do is construct a range of scenarios (for example, our 12-month targets for the S&P 500 range from 1400 to 3000).
We have witnessed extreme market volatility in recent weeks, and I can imagine three potential circuit breakers (against the panic): a working and approved vaccine, a clear reduction in COVID-19 cases and deaths outside of China, and policy support. Given that a vaccine is unlikely to be available for 12-18 months, in my opinion, and that non-Chinese cases and deaths continue to accelerate (with the US now becoming the center of attention), it has been left to policymakers to calm the markets.
While governments unfurl ever larger fiscal packages to protect their economies, major central banks have announced massive asset purchase programs, which have the double effect of calming markets and effectively financing the surge in fiscal deficits. Our projections for the aggregate balance sheet of the major central banks (Federal Reserve, European Central Bank, Bank of England, Bank of Japan and Swiss National Bank) suggest that expansion in the period to end-2021 may be as rapid as has been seen in the last decade (in year-on-year percentage terms). It is also our observation that such growth has tended to be followed by improved performance in global assets (according to our own global multi-asset benchmark).
However, it seems that we are in unprecedented times, and it is difficult to yet quantify the economic damage wrought by attempts to control COVID-19. Our very worst-case scenario (from which the S&P 500 1400 target arises) imagines that global gross domestic product (GDP) could shrink by 3.5% this year and that markets return to Global Financial Crisis conditions (in most cases, we remain far from that).
Consequently, and as I mentioned in my brief remarks in last week’s blog, diversification is more important than ever but is harder to achieve than usual, given that assets are moving together (correlations have risen). Among “defensive” assets, I believe cash and gold warrant the greatest consideration for investors. Government debt could also fulfil that defensive role now that major central banks have launched big purchase programs, but yields are historically low and government deficits could reach war-time proportions (in my opinion).
I believe a barbell approach of combining those “defensive” assets (cash and gold) with commodities and real estate (REITs) could offer potential benefits. They are the cyclical assets that I think have the most upside under our more optimistic scenarios.
Equities may also be an important part of any long-term investor’s portfolio. Equity markets that I believe have the most upside potential in the shorter term include the UK and Japan. However, on a global basis, I think there may currently be more efficient ways than equities to gain exposure to an economic recovery (for example, a combination of investment grade credit, REITs and commodities may potentially provide such exposure).
One asset class I would highlight in today’s environment is investment grade (IG) credit. In my view, IG would seem to offer a good combination of risk, reward, and diversification potential. I am, however, more wary of high yield credit, echoing Tim’s comments above.
Finally, some assets have been more impacted than others and have priced in a greater degree of bad news. In my opinion, this list includes oil (the price of West Texas Intermediate briefly touched my long-held downside target of $20 on March 30); sterling, which fell to around 1.15 on March 19 and close to historical lows versus the US dollar; and REITs (the global yield was 5.3% and US yield was 5.6% on March 26, based on FTSE/EPRA NAREIT indices).4 Given this view, UK oil stocks may warrant consideration, as they give access to oil assets in a depressed currency.
Talley Léger is a Senior Investment Strategist who specializes in the equity markets for the Invesco Global Market Strategy team.
Tim Horsburgh is an Investment Strategist who specializes in fixed income markets for the Invesco Global Market Strategy team.
Paul Jackson is the Global Head of Asset Allocation Research for the Invesco Global Market Strategy team.
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