Multi Assets: Building resilient portfolios through market cycles

2020 was a year nobody expected, but most quickly adapted to. The pandemic drove an indiscriminate market sell-off in March. In our view, this was less about systemic risk and more a coping mechanism when faced with a crisis of uncertain depth and duration.

Governments and central banks reacted quickly: The U.S. Federal Reserve (Fed) cut rates by 150 basis points, bringing the target range down to 0% to 0.25% and enacted extensive liquidity provisioning measures.¹ Trillions of dollars in stimulus, including wage subsidies and furloughs, were also approved by governments across the globe. These measures supported global economies at the onset of the COVID-19 pandemic. Capital markets, however, reacted much more positively: strong momentum in risk assets drove equity performance, as well as gold, which broke the US$2,000 per ounce mark² for the first time. Meanwhile, GDP figures unveiled the full depth of the recession, with G20 countries seeing a 6.9% fall in growth for the second quarter.³ The United States experienced a 31.4% decline,⁴ while the United Kingdom,⁵ Japan,⁶ and India saw drops of 19.8%, 27.8%, and 23.9%,⁷ respectively. China was the exception, returning to modest growth in the same period.⁸

However, in September and October, we saw sentiment dim as uncertainty surrounding the U.S. presidential election came to the fore. In the period following the election, risk assets rallied strongly, particularly with the addition of positive vaccine-related news. Risk assets extended gains in the postelection rally; for equities, the MSCI U.S. and Asia ex-Japan indexes outperformed.⁹ Sector wise, information technology (IT) and consumer discretionary led throughout the year, as COVID-19-related lockdowns drove increased demand for higher-growth equities and corporates with online ecosystems that could sustain their business models better during the pandemic. Toward year end, the breadth of the rally expanded to cyclicals and value stocks. Within fixed income, global corporate bonds took the lead, gaining 9.0%, while the broader Bloomberg Barclays Global Aggregate Index gained 7.8%.

Global high-yield and emerging-market (EM) bonds delivered 5.0% returns.¹⁰ The latter part of the year also saw U.S. dollar weakness which, on top of some rotation out of U.S. growth assets into global cyclicals and value, also added to the investment thesis arguing for an increased exposure to non-U.S. dollar assets.

On the equity front (and geographically speaking), we believe that market liquidity will continue to support U.S. share prices in 2021 especially as short-term risk factors, such as U.S. political uncertainty, dissipate. Global politics, however, will continue to grab the headlines, particularly relations between the United States and China—even under a new Biden administration. EM stocks, bolstered by supportive monetary policy and being heavily levered toward global trade and manufacturing, should also continue to outperform in the recovery. Two regions—the United States and Asia (largely China)—are preferred when considering tactical positioning. 

On a sector basis, we could see the IT sector continue its leadership trend; however, the sector may come under further tax and regulatory scrutiny under the Biden administration. Consumer discretionary is another sector in focus, despite elevated valuations. From a style perspective, we’re aware that further stimulus and the reopening of economies could spur a second wave of rotation away from growth into value and cyclicals. Value sectors may seem relatively cheap, but our concern is that they could remain just that. As such, having some exposure at this stage is, we believe, the right approach. Supported by low interest rates, a growth bias still holds favor, although in the near term, some cyclical and value-oriented markets, such as Europe and Japan, are worth considering.

We expect the Fed to keep rates at the zero lower bound, without dipping into negative territory. However, such a low-yield environment is a recipe for anemic fixed-income returns in developed markets (DM). 

Therefore, EM debt and global high-yield issues are in scope. The former boasts improved valuations plus the potential of even greater yield for local currency issues (albeit at the expense of higher volatility). Similarly, continued near-term uncertainty should offer investors attractive entry points for global high-yield bonds. Meanwhile, corporates are seeing better access to capital, which should improve their credit risk metrics and ameliorate default rate expectations. As we shift beyond this near-term tactical view and explore longer-term strategic ideas, specific themes become more prominent.

Structurally, the Fed’s liquidity boosting measures and persistently low rates will likely see the U.S. dollar gradually weaken over time. This should present a moderate tailwind for EM assets, further supporting our strategic overweight stance toward such assets. 

That said, we bear in mind that U.S.-China tensions will remain a key talking point, even under the Biden administration. Assuming a smooth transition to a new U.S. administration on January 20, we don’t expect any material change in U.S. foreign policy toward China, nor do we anticipate an imminent unwinding of the tough measures imposed by the Trump administration (e.g., trade tariffs, revoking of visas, sanctions, and travel restrictions). Indeed, the Biden administration’s decision to prioritize climate change and human rights may present new challenges for U.S.-China relations. Meanwhile, the potential for financial decoupling has risen—if the United States follows through with additional financial sanctions on Chinese corporates as well as threats of further action. 

Beyond the United States, the larger Western trading blocs’ perception of China will also have geopolitical implications. Deglobalization is likely to continue rearing its head as we move forward and may push economies toward smaller, more regional trading groups. These structural themes reflect long-term strategic views, some of which differ from more tactical considerations.

For our five-year strategic outlook, investors can favor EM, both within equities and fixed income. Continued supportive monetary policies, a more synchronized global cyclical rebound, and a weaker U.S. dollar should allow EM equities to maintain a robust growth profile with attractive long-term valuations. A successful vaccine rollout will be a game changer for the economies of Latin America, Indonesia, and India; however, a medical solution is unlikely to drive a robust and rapid economic solution. Fiscal stimulus is unlikely to be enough to spark a rapid economic recovery as a return to pre-COVID-19 growth rates is likely to be pushed into 2022. Nevertheless, on a relative (strategic) basis, we see higher equity and fixed-income returns in EM versus DM.

Within EM, Asia is more attractive given its healthier economies versus Latin America and emerging Europe. A relatively stronger starting point in Asia versus the rest of the broad EM space lends to a higher probability of targeted stimulus measures and the relaxation of credit standards. In the United States, higher valuations and a weakening U.S. dollar mean that investors can take a more strategically neutral stance toward its equity sector over a longer time horizon.

From a multi-asset perspective, in a world where investors are feeling increasingly compelled to reach for yield, we believe that the most attractive opportunities lie outside of the sovereign debt space, making investment-grade global credit and high-yield issues a preference. While investors must keep an eye on specific sectors that have a much more binary outcome determined by the path of COVID-19, such as energy and healthcare, we believe there’s adequate room to run within this segment over the next five years.

2020 saw investors embrace risk despite one of the most distressed macro environments in a century; 2021 should be about balancing what feels like market complacency with rising risks. The key market drivers for 2021 are likely to be the Fed and the U.S. dollar, government stimulus efforts, China, the pathway of COVID-19, and vaccine success. We expect the Fed to be more reactionary than it was back in the spring of 2020 in anticipation that the end to COVID-19 lockdowns will release pent-up economic demand, spurring a consumer-led recovery. The expansion of the Fed’s balance sheet has stalled and growth in balance sheet expansion has been sideways since June 2020. 

Geopolitics will remain a headline risk. We don’t expect the Biden administration to remove phase one tariffs on Chinese imports, with expectations of few changes to policy in the near term. The United States and Europe, however, could see improved relations under Biden.

That said, there’s opportunity within ambiguity. We believe that investors’ interests can be well served by focusing on macro themes and combining them with capital market asset allocation views within a risk management framework. This should point the way to capturing opportunities while managing potential downside and upside risks, providing investors with sustainable and resilient solutions that can withstand market cycles. 

1 “Federal Reserve announces extensive new measures to support the economy,” U.S. Federal Reserve, March 23, 2020. 2 Bloomberg, as of July 28, 2020. 3 “Unprecedented falls in GDP in most G20 economies in second quarter of 2020,” OECD, September 14, 2020. 4 Bureau of Economic Analysis, October 29, 2020. 5 Office for National Statistics, September 30, 2020. 6 Japan’s Cabinet Office, August 17, 2020. 7 National Statistical Office India, September 2, 2020. 8 National Bureau Statistics of China, July 17, 2020. 9 FactSet, as of November 30, 2020. MSCI U.S. and MSCI Asia-Pacific ex-Japan equities gained 16.6% and 15.0%, respectively, versus MSCI World, which gained 11.72% year to date. 10 FactSet, as of November 30, 2020.