Putnam Investments hosted a webcast on March 18 featuring insights on current volatility from three senior investment managers.
- The coronavirus (COVID-19) pandemic is causing a triple market shock — to supply, demand, and liquidity
- Monetary and fiscal policy makers are taking appropriate responses, but at too slow a pace
- Market prices are not yet at the level we consider constructive for adding risk to portfolios
We are maintaining our defensive position and are not ready to add risk back in. Policy responses are happening, but slowly.
For the liquidity issues, we have seen a reasonably sizable response from central banks. Having gone through this in 2008, policy makers are in a better place to respond. These measures take time to work their way through the system.
For the demand shock, we believe fiscal policy needs to come to the fore. We are starting to see that in a big way. The United States is talking about $1.2 trillion response to the demand shock, that’s about 6% of GDP. The eurozone is responding to the demand shock as well. We expect fiscal stimulus, such as putting cash in people’s pockets, will have a positive impact on demand, but the timeline is uncertain.
As for the supply shock, we are still uncertain about the virus spread. The ramp-up is just beginning in the United States. We lagged behind other countries in testing. The data is going to get worse at this point. We don’t know yet whether there will be additional waves of the pandemic in the future.
We are looking for signs of true capitulation before we would consider adding risk back to the portfolios. The passage of time is going to be a critical thing. There are many unknowns. People in the United States have no experience with lockdowns and sheltering in place for weeks. How sustainable is this? The reaction of the virus and the data as testing gets rolled out is also unknown.
We favor underweights to commodities, high yield, and risk assets. When is the right time right to get back into risk assets or close those short positions? One of the primary considerations is the pace of transmission of the virus and its impact on the health-care system. Until we have better information on the spread of the virus and its impact around the world, we will be hesitant to dip our toe back into risk.
In our opinion, three policy areas need action. In monetary policy, the Fed’s move on Sunday, March 15, was impressive. They lowered interest rates to zero and opened up the channels for the purchases of Treasuries and mortgages. There was an initial disappointment for the commercial paper (CP) and corporate bond markets, but the CP funding facility has since opened up and that is providing some stability to the front end of the curve. That is good. There is a lot more access now to trade in the CP and repo markets. We would expect that to extend out to the other parts of the market. Clearly there is demand.
Second is fiscal policy. We typically would expect some delays and hiccups. Policy makers are learning from previous crises. So the good news is that we believe this will come into play much faster than it would under normal circumstances.
Third is public health policy. Unfortunately, there is no way to fast-track health measures. Everyone is trying to figure out the scope, the dimensions, of this pandemic. This period of uncertainty will continue, unfortunately, for the foreseeable future.
That brings us to recession risk. Tail risks have risen meaningfully. Recession is on the table. We have seen a dramatic sell-off in Treasury bonds.
At this point, we are not ready to add risk to portfolios. We favor keeping risk on the low side. The biggest risk in the fixed income markets since 2008 has been liquidity risk. We are seeing that now in spades across most of the fixed income markets. These dislocations are everywhere. Correlations are off, even between traditional risk-off assets. We have seen a number of situations in which equities and Treasuries are both selling off hard at the same time. Credit spreads are making very little sense in this market because you are seeing these dislocations. When you see spreads in the market that are not associated with each other, it is not a good time to be adding risk, in our opinion. We are focused on managing the liquidity risk in the portfolios. We entered the situation with relatively high cash levels.
Equity market tends to be most visible when turmoil strikes, and it’s difficult to ignore headlines. We take a long-term view. We focus on the process we’ve had in place for years. Active management should be able to shine in a market where everyone is nervous or fearful.
Markets tend to focus on similar events in history. What we are experiencing now has no historical precedent, and markets are reacting very aggressively to this. Investors are moving to what they view as the most attractive asset — cash. Airlines are asking for unprecedented support. Government intervention could set up a quandary for equity investors.
We are trying to understand the existential risk in the names we hold or the names that might be interesting. This is not like anything we’ve witnessed, but it’s also not a blunt instrument. Look at the consumer staples retailers, like grocery stores. They are holding up well, but in consumer discretionary, many retailers’ very existence will be called into question.
We are seeing vastly lower earnings and vastly lower multiples. Defensiveness and quality have been favored. Risk-on and cyclical strategies are underperforming dramatically, but it has been relatively predictable. How long can you survive with your business closed? We are talking to managements, asking about contingency plans. Many companies are dusting off their playbooks from 2008.
As for earnings, some are estimating 10% down, but we expect that we will see something much more draconian for businesses like cruise lines, which have dropped close to 100%. Since the 2008 crisis, we as stock pickers recognize that there will be vast differences between winners and losers. This is different in the context of what to expect in earnings and valuations. The opportunity is there to differentiate between winners and losers at the individual company level. That’s what we’re paid to do.
The multiples are also falling, and it is difficult to determine if investors are willing to pay up for earnings. We are focusing on each company’s ability to manage the crisis. Trying to anticipate a broad earnings outlook is a fool’s errand.
It’s important to understand that this may eventually pass — and how do you want to be set up for that? We focus on fundamental outcomes, company by company, within each sector. Within each sector, we recognize there are risks we don’t know, but we aren’t burying our heads in the sand. We seek to take advantage of dislocations. We don’t focus on a 5-minute period, but 5 years.
We have rigorous risk control and portfolio construction. We’re looking to diversify the alpha as well as the risks, keeping us away from beta and large sector bets. We were fairly well prepared for this market with no big sector bets.
The source of an exogenous shock will always be different, and this one has an unknowable end. We pursue outperformance in the market when it’s up and when it’s down.