April saw a rebound in risk assets as markets were buoyed by the prospect of economies slowly reopening for business as the number of new COVID-19 cases appear to have passed their peak in many key economies around the world. Markets were also supported by ongoing policy actions from central banks and governments, which has seen liquidity in markets significantly shift from being problematic a couple of months ago to being flush with liquidity as central banks ramped up their asset purchasing programs.
Economic news however continues to be poor. The Australian unemployment rate rose from 5.2% to 6.2% in April. What this figure does not factor in is the number of people who have effectively exited the labour force as well as people who are underemployed as a result of their work hours being reduced. In the US, unsurprisingly retail sales took a significant hit dropping 16.4% in April, with clothing sales down by about 80% since the end of February. Only food consumption was up by 10%, which was no doubt fuelled by ‘panic buying’. Amidst the negative news, Chinese industrial production continued to show signs of rebounding.
A key question we are asking ourselves is to what degree the negative economic news has been priced into the market and to what extent will markets continue buying into the central bank liquidity story. We believe that markets have factored in some of the bad economic news however much will depend on how quickly economies can reopen and that the rate of COVID-19 cases remains stable. Central banks have responded rapidly, and the scale of response has been unprecedented. However, a spike in cases and economies re-entering a ‘lockdown’ scenario would be negative for markets.
Our most recent asset allocation change was to move towards our neutral weight to equities reducing our alternatives and cash allocation. Our asset allocation views take a 18 month to 3 year view and while we see risks ahead and economic news is expected to be poor, we are also seeing valuation opportunities in some asset classes. Policy and liquidity are conducive to risk assets and risk indicators such as the VIX Index have been moderating.
However, we remain cautious and from a bottom-up investment perspective we have been focused on further diversifying our portfolios. Within equities we are seeking to increase our exposure to managers, sectors and stocks which have a bias towards companies with more sustainable earnings and sound balance sheets. In terms of income, we are factoring in a 30% reduction in income from dividends and we are seeking to diversifying our sources of yield to certain segments of the credit market particularly within our retirement focused portfolios. Finally, we have been adding a small exposure to gold within our multi-asset and listed portfolios. Gold provides defensive characteristics during deflationary periods and times of economic uncertainly. Additionally, it can act as a good hedge against inflation, which while not a concern today, may be an issue in the future given the scale of monetary and fiscal stimulus supporting economies currently.
Stay safe and healthy.