Earnings season is heating up in earnest, giving investors a clear glimpse into the economic impact of the global lockdowns designed to slow the spread of the coronavirus. While investors brace themselves for bleak business results, we are so glad to see that these lockdowns appear to be working as intended from a public health perspective — many countries show evidence of “flattening the curve” of infections and fatalities. This is leading to the inevitable conversations of how best to re-open economies — a task that will require caution so as not to overwhelm health care resources with a second wave of infections.
With all of this as background, our portfolio managers continue to look for ways to guard against the looming risks and to position themselves to find opportunities in the recovery — no matter what path that might take. In this edition, I highlight the perspectives of four Invesco investment experts:
- Joe Rodriguez, Chief Investment Officer, Invesco Listed Real Assets team
- Clas Olsson, Chief Investment Officer and Senior Portfolio Manager, Invesco International and Global Growth team
- Scott Wolle, Head of Systematic and Factor Investing; Chief Investment Officer and Portfolio Manager for the Invesco Global Asset Allocation team
- David Millar, Head of the Invesco Multi Asset team
Real estate: Which property types might benefit from recent trends?
Joe Rodriguez: The coronavirus pandemic is a clear and unexpected inflection point for global economic prospects. In times of uncertainty, the tangible nature of real estate and its contractually binding rents can provide portfolio diversification and premium income potential for investors. While overall earnings from real estate are likely to diminish in 2020, we expect them to rise again as current macroeconomic challenges subside. However, we also believe that there may be pitfalls that occur, and one must be highly selective in selecting the proper companies in which to invest.
Our portfolios continue to maintain an overall bias towards companies with higher-quality property portfolios, lower-leveraged balance sheets and, most importantly, above-average earnings and asset value growth potential. Within our portfolios, we believe that the residential sector should continue to benefit from the structural undersupply of housing. Life science complexes, last-mile industrial properties, and grocery-anchored centers also may provide resilience for investors. Furthermore, essential wireless communication infrastructure and data center REITs (real estate investment trusts) may receive some positive impact from an uptick in online shopping and the work-from-home environment. For fixed income investors, we believe that the preferred equity segment of the real estate capital structure offers highly attractive yield characteristics in a world where interest rates have hit new lows.
In our view, the stock prices of publicly traded REITs offer attractive valuations relative to the long-term value of the underlying properties which they own, as well as attractive yield spreads relative to US Treasuries and investment grade corporate bonds. For these reasons we believe that real estate securities may be an interesting option for higher income value and diversification potential as part of a wider portfolio asset allocation.
International equities: Dislocations in global markets create unique buying opportunities
Clas Olsson: The lockdown of most of Europe, parts of Asia, and the US creates a tremendously uncertain outlook for global economic growth. What is clear is that economic and earnings growth projections need to be materially reduced as end demand falls and supply gets disrupted.
To counter these economic headwinds, most global central banks (e.g., Federal Reserve, European Central Bank, Bank of England, etc.) have announced countermeasures, including aggressive interest rate cuts, quantitative easing, and other liquidity measures. Many governments are also considering a variety of fiscal policy responses to offset the shortfall in economic activity. How effective these measures will be remains to be seen.
Not surprisingly, the COVID-19 global lockdown has led to a sharp market sell-off, initially punishing cyclical stocks but even higher-quality companies also fell sharply. This has created numerous new opportunities — across many sectors and countries — for active managers like ourselves to buy great businesses at attractive prices. Our strategy is long-term-oriented, therefore we believe market corrections provide attractive opportunities to establish positions in undervalued, high-quality businesses.
Our team always maintains a “Watch List” of stocks in case volatility does provide such opportunities (as was the case in 2016 with the Brexit referendum and also during the fourth quarter of 2018 with trade war tensions). Our focus remains on companies with strong balance sheets, high returns on invested capital, and attractive free cash flows, which we believe should help them to withstand a prolonged period of stress.
Commodities: A hedge against a potential rise in inflation
Scott Wolle: Commodities tend to perform best in periods with at least moderate real growth and rising inflation. However, the COVID-19 pandemic and associated social distancing measures have had a sharply negative impact on both growth and inflation, and we saw the impact to commodities in the first quarter. The S&P GSCI Light Energy Index, a benchmark of broad commodity market performance, lost more than 27% during the first quarter — a quarterly fall that’s been surpassed only three times since 1974.1 Within the wide-ranging commodity sector, the S&P GSCI Energy Index fell more than 50% in the quarter, while gold led the way with a gain of 4% despite heavy selling pressure in March as investors indiscriminately sold assets in order to raise cash.1
To prevent permanent damage to the economy from the impact of COVID-19, the scale of the policy response has had to be enormous and has married fiscal and monetary approaches. In assessing the future inflationary impact of this policy response, we must admit that it’s too early to tell. Much depends on how the large deficits incurred to fight the pandemic are financed. For example, if the US finances the deficit through increased taxes or borrowing from the non-bank public, the risk of elevated inflation would be low. If the deficit is financed through borrowing from banks or primary purchases of debt by the central bank (printing money), the risk of inflation would be much higher.
High inflation is generally harmful to financial assets because their future cash flows have less real spending power as inflation increases — so we believe commodities are best viewed as a hedge against inflation that is unexpected or not fully priced into markets (in addition to their potential to participate in an economic recovery). As for which commodities are likely to do best going forward — that’s a difficult question to answer because there are so many variables to correctly gauge. In assessing the impact on individual commodities, it’s critical to consider supply in addition to demand because commodity producers will likely have to drastically reduce production and/or capital spending. A supply shock is a future risk because we have had an extended period of low prices that has required producers to develop only the highest-quality/lowest-cost portions of their geology. As a result, even if demand does not return to pre-crisis levels, supplies could be constrained over the coming years.
We believe in taking an active, diversified approach to commodities that avoids being too concentrated in one sector (energy) while also emphasizing commodities with the highest scarcity value. We see diversification as a bigger opportunity within commodities than in stocks and bonds given the historical performance differences between commodity sectors. (Once again, compare the 4% gain for gold against the 50% drop for energy in the first quarter of this year.) We also believe it’s important to have a flexible component within a commodity strategy, so the individual exposures and risk profile can be best matched to the prevailing opportunity.
Multi asset: Finding investment ideas in a difficult-to-read environment
David Millar: Asset price movements over the last few weeks have been enormous — unparalleled even during the global financial crisis. A month ago, markets were in free fall with remarkable sell-offs across risk assets from equities to oil. However, the recent rally has seen some parts of the market already return to February highs, particularly in credit where the impact of the US Federal Reserve’s actions has been tremendous.
However, the dramatic “I-shaped” recovery that we have seen in many risk assets appears to leave some scope for disappointment, especially as the recovery from the coronavirus is likely to be much more drawn out after delivering such a devastating economic blow. Markets have been gyrating wildly based on things on which they do not or cannot have total clarity. Since the global financial crisis, the build-up towards greater volatility in underlying economies, companies, and politics has been visible, yet time and time again central bank liquidity has managed to keep asset price volatility at historically low levels. This time, it would appear that volatility in assets is most definitely back.
What impact might it have on the behaviour of investors if the perceived ease with which they garnered returns in the past is challenged? Having experienced a recent history of incredibly low volatility, will investors still believe they can manage it on their own, or will they prefer to seek out solutions that offer the potential for smoother returns?
Our approach has always been to take a longer-term view of markets, and we believe this is as important as ever right now. The shift from supporting the economy through monetary policy alone into “synchronized” monetary and fiscal policy support is significant and will affect the longer-term debate of inflation versus deflation. Over a two-year time horizon, we believe the deflationary impact still wins. The hit to stock price earnings across many sectors from a near-total global shutdown is significant as well. We are wary that equities may have recovered too much too soon, and we prefer credit markets where the Fed, as well as the European Central Bank, is now a backstop. With directional plays looking exhausted in some parts of financial markets, and difficult to read in others, relative value investment ideas — which are designed to benefit when one asset outperforms another — will be increasingly important drivers of investment returns, in our view. Our “investing in ideas” approach has led us to relative value investment opportunities across asset classes such as currencies, equity sectors, and emerging markets.
^1 Source: Bloomberg, L.P., Jan. 1, 2020, through March 31, 2020