In times of extreme market volatility as we are experiencing with the COVID-19 pandemic it can be useful to take a step back and think about what has happened and how that might inform our preferred positioning going forward. Three important questions come to mind in terms of how we think about our portfolios and investment strategy:
- Valuations: Has the selloff improved the skew of potential returns on risky assets?
- Sentiment: Is there evidence of a capitulation or panic that suggest risk premia are more attractive?
- Cycle: Can we formulate a differentiated view on the economic and earnings damage from COVID-19?
Our assessment of equity market valuations—on a medium- to longer-term horizon—has moved markedly. We entered this selloff with the understanding that the U.S. equity market was very expensive. Based on current pricing, interest rates and earnings estimates, the U.S. equity market is now trading in a range that we would judge to be fair value. From a global standpoint, we view equities as now cheap, with particularly large and unusual discounts being priced in the UK equity market, for example.
Similarly, high yield credit spreads, as measured by the Bloomberg Barclays Index—which were unusually tight and unattractive in mid-February—blew out to 660 basis points as of yesterday’s close (a level of compensation moderately above long-run historical norms). Meanwhile, safe haven assets look more expensive. The 10-year Treasury yield, currently trading at 78 basis points, effectively already embeds a view that the U.S. Federal Reserve will cut interest rates to zero and keep them there for a very long time. While that view may prove to be correct, the balance of risks and skew of outcomes this close to the lower bound suggests more upside than downside potential to yields from here—assuming we get to the back half of virus-related impacts and see risk aversion normalize.
We evaluate market sentiment with a lens on price momentum and whether the collective psychology of investors has pushed to an extreme of panic or euphoria. While price momentum for risky assets has deteriorated, a number of technical, positioning and survey-based indicators suggest to us that we are very close to one of those panicked extremes today. There are no guarantees in finance, but historically these episodes have offered long-term investors an opportunity to collect extra risk premia when other investors are afraid. Times like these are when clients can be rewarded by staying invested and maintaining conviction in their strategic plans.
Finally, on the business cycle, as we’ve written about before, we do not claim to have any unique insight on the future contours of this virus. That is, in part, informed by a humble recognition that many of our expertise lies in the fields of economics and finance. But we have also talked to medical experts on this issue, who have told us that forecasting and timing the extent of the virus is effectively impossible.
We recognize that there could be potentially severe disruptions to global economic and earnings growth over the next few months as factories are closed and travel is restricted. But whenever we do get on the back side of these virus effects, we believe we’ll likely enter an environment ripe with pent-up demand and aggressive monetary and fiscal tailwinds at our backs.
Excerpt taken from: Russell Investments Article, Coronavirus watch: Our latest assessment of markets as global rout continues by Paul Eitelman