Ben Bennett, Head of Investment Strategy and Research
Trick? Q2 GDP was the weakest ever, collapsing by -32.9% as the economy shut down during the first virus wave.
Or treat? But Q3 has smashed the previous record at a whopping 33.1%, with the US economy surprising many economists by the strength of its rebound.
My takeaway: Despite this remarkable V-shaped recovery, I believe this record number is a trick. There are plenty of uncertainties looking ahead, such as further COVID-19 waves, the US election, a new fiscal package, and the timing of a vaccine. We think growth has flattened off in recent weeks and unemployment is likely to stay high for a long time to come. That said, we hope growth will re-accelerate once a successful vaccine is deployed next year.
Iancu Daramus, Senior Sustainability Analyst, Investment Stewardship
Trick? To limit climate change, we need to reduce both the flow and the stock of emissions in the atmosphere. Each is a daunting task in its own right, and the interplay of these two forces explains why 2020 – a year of record reductions in energy emissions – is also likely to be the warmest year on record. In short, like the recurring ghouls of All Hallows’ Eve, the fact that the modern economy was built on fossil-fuel burial ground is likely to haunt us for quite some time.
Or treat? Obviously it is an imperative rather than a treat, but it is encouraging that there is growing policy consensus around the need to reduce new emissions to ‘net zero’ globally. In just the past week, South Korea and Japan have both pledged to reach carbon neutrality by 2050, following China’s 2060 target announced earlier this year. This marks an important shift, with other coal-reliant Asian nations such as the Philippines, Vietnam and Bangladesh cancelling or planning to significantly curtail new coal power projects.
My takeaway: We know progress is possible, and we will continue to work with companies, other investors and policymakers towards a world where ghosts remain the biggest threat in the air on Halloween night.
(For more on this topic, please watch out for a forthcoming blog by Iancu)
Madeleine King, Co-Head of Global Investment Grade Research
Trick? Pandemic-related pressures on non-financial corporates caused a jump in global investment-grade corporate leverage in the first half of this year, and we think things have continued to get worse since then, with the deterioration accelerating through the second half of 2020.
Or treat? The good news for bondholders is that companies across sectors continue to focus on cost cutting and have shown that they are willing to slash dividends to protect their balance sheets where necessary. Even in the most bearish scenario – where the global economy does not significantly rebound next year – we expect corporate leverage to recover substantially in 2021.
My takeaway: Despite next year’s expected repair of balance sheet, most companies will take a long time to recover fully, and by the end of 2021 we expect leverage in most sectors to remain above historical levels. This suggests that we’re not at the end of the credit downgrade and fallen angel cycle yet. Bondholders should expect rating actions to pick up again in 2021.
Willem Klijnstra, Strategist, Asset Allocation
Trick? Realised inflation, already haunted by the pandemic, could massively undershoot if further waves of the virus hit the economy without an effective vaccine being found – or overshoot if more and more stimulus is pumped into the economy while the Federal Reserve will be willingly behind the curve, having recently moved to average inflation targeting. A wide distribution of inflation outcomes could be a bad omen as it reflects investors’ uncertainty, which in turn could keep market volatility high.
Or treat? Recent inflation readings have indicated a steady recovery in prices since May’s nadir, but of course that doesn’t preclude a devilish sting in the tail.
My takeaway: Looking at inflation expectation surveys, there is little evidence yet of a wider distribution. This may also explain why there continues to be a positive correlation between inflation pricing and risk assets, with the recovery in equity markets being a welcome treat for investors.
Martin Reeves, Head of Global High Yield
Trick? Some have argued that the rebound in high-yield bond prices is over, given their swift rally from the wides of March and lingering uncertainties about the economic outlook.
Or treat? The chart shows the changes in spread levels in US BB-rated bonds during the 24 months following various market crises. Looking at these previous experiences, not only has the high-yield market rebounded quite quickly after significant selloffs, but that rebound has continued for periods of a couple of years.
My takeaway: By mid-2021, we believe a combination of factors – including further stimulus, historically low default levels, and improved issuer credit profiles – could push spreads to record lows and create a strong demand for high-yield bonds.
(For more on this topic, please watch out for a forthcoming blog by Martin)
Aanand Venkatramanan, Head of ETF Investment Strategies
Trick? Green power prices from many different technologies continue to fall, but there are lingering questions about the intermittency of some renewable sources of energy.
Or treat? The world desperately needs lower-carbon sources of power, as Iancu highlighted, and the sharp fall in solar and wind costs made renewables cheaper than coal and gas in 2019. According to IRENA, further cost reductions due to steep experience curves are still set to continue into the next decade and could be a vital driver of the energy transition.
My takeaway: I believe renewable energy is here to stay and expect it to continue to enjoy strong growth, as the economics are much more favourable now than when compared with even five years ago. Demand for power is set to increase globally and – with offshore wind and solar (and potentially onshore wind too) set to become much cheaper than most other forms of energy, and battery technology improving to overcome the intermittency challenges – the conclusion is fairly simple.
Justin Onuekwusi, Head of Retail Multi-Asset Funds
Trick? The concentration conundrum can leave investors exposed to an undesirable degree of idiosyncratic risk. For example, the big tech companies face potentially grave risks and a techlash could mean a dead end for the sector, turning into a Nightmare on Wall Street.
Or treat? This concentration in so few stocks could nonetheless be a treat for investors as it leaves them more exposed to the strongest businesses in the market, almost regardless of the pandemic keeping people working remotely, purchasing their groceries online, or maintaining social distance using their mobile phones.
My takeaway: We still like tech and don’t think rich valuations will spook investors yet, as the current environment is likely to stay positive now we’re experiencing a breath of fresh scare, but over the longer term we are concerned by that concentration in so few stocks.
Raza Agha, Head of Emerging Market Credit Strategy
Trick? Emerging markets’ debt levels are sitting at two-decade highs.
Or treat? Much of this debt is being refinanced at rates also close to two-decade lows.
My takeaway: This suggests there is an opportunity for active emerging market strategies that focus on credit selection at a time when heightened scrutiny is warranted.
John Southall, Head of Solutions Research
Trick? I love thought experiments. Imagine you can own one of two portfolios illustrated in the chart: (A) 1,000 assets, each with an annual volatility of 10% and each 50% correlated to every other asset in the portfolio; or (B) just two assets, each with an annual volatility of 10% but with a correlation of zero to each other. In both cases, the assets are equally weighted within the portfolios, so portfolio (A) has 0.1% invested in each asset whereas portfolio (B) has 50% invested in each asset. Which, intuitively, would you say has lower volatility – portfolio (A) with 1,000 assets or portfolio (B) with just two? The answer to this slightly trick question is actually (B). The volatility of (A) is 7.075%, whereas the volatility of (B) is fractionally lower at 7.071%. In fact, you'd need an infinite number of assets in portfolio (A) to get the volatility as low as in (B).
Or treat? Despite working with models of investment risk on a regular basis, and working through the algebra that proves it, I find this result quite surprising. It’s something of a treat to realise and demonstrate that finding just one uncorrelated return source can be as beneficial as finding an endless source of returns that are moderately correlated to everything else.
My takeaway: Implicitly, what's happening is that all the assets in portfolio (A) share a common risk factor that can't be diversified away. One key takeaway is that it's important to cast a wide net and seek out different return sources. But another is that even if a diversification strategy appears visually impressive in a pie chart, that may not tell the whole story. After all, as illustrated, the pie chart for portfolio (A) looks more compelling than the simplicity of (B)!
(John discusses this topic in more detail in this blog)
Chris Teschmacher, Fund Manager, Asset Allocation
Trick? As asset allocators, government yields being effectively six feet under forces us to confront a scary possibility: the traditional portfolio use of sovereign bonds may be dead and buried. This persistently low-yield environment reduces both the asset class’s return prospects and risk-mitigation qualities. This year’s experience doesn’t bode well, with the typical magnitude of the fall in bond yields on weak S&P 500 days shrinking markedly, while the chance of bonds failing to rally altogether has gone up.
Or treat? Low interest rates should in theory act as a form of stimulus, leading to firmer growth expectations and better equity returns. That’s all well and good for the risk assets in a portfolio, but the trick is that it’s still increasingly difficult to justify the role of traditional sovereign bonds in portfolios if they can’t offer a safe harbour in periods of risk aversion.
My takeaway: Fortunately, we are not beholden to zombie thinking about portfolio construction and have plenty of ‘sweeter’ options in our bag: we can diversify into alternatives, seek steeper yield curves that can still compress further, give a greater role to currencies in risk management, and benefit from alternative risk premia among other techniques to balance risk mitigation with return replacement.
David Jackson, Equity Analyst
Trick? Value equities have underperformed the market, in stark contrast to growth stocks, especially in the past six months.
Or treat? The relatively flat price-to-earnings multiple attached to value stocks, despite the price drop, implies that expectations of their earnings will be reduced by a similar proportion for the foreseeable future. This is not in keeping with the economic forecasts for recovery.
My takeaway: Historically, the longer the style underperformance, the stronger the reversion. Although we cannot predict the timing of the ‘dam breaking’, it is apparent that the pressure is building.
(For more on this topic, please watch out for a forthcoming blog by David)
Corinne Lewis-Reynier, Head of Fixed Income Investment Specialists
Trick? Past performance is no guide to the future and investors shouldn't count on another decade of financial repression.
Or treat? This growth of negative-yielding corporate bonds demonstrates that credit investors can continue to receive positive returns in fixed income even when rates seem low; it is also encouraging that companies can continue to issue debt at attractive rates, suggesting that default risks may be overstated.
My takeaway: Super-easy global monetary policies mean that this trend is likely to remain an important feature of corporate bond market demand going forward, so appropriately positioned investors could be in for a treat.
Emma Douglas, Head of DC
Trick? Millennials in our research were the most likely out of the three generations to want to remain invested in companies that have been criticised for their governance and pay practices.
Or treat? Female Boomers and Generation X, on the other hand, were the most likely to divest from companies with poor governance and pay practices.
My takeaway: It was notable that those who care about pay tended to have been in the workforce longer and so have seen the tangible effects of the global financial crisis and other crashes on employment and stability.
(To read our full DC member research report, please click here)