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Special Focus

March 2020

Viral volatility

Vasu Menon, 
Executive Director,
Investment Strategy,
Wealth Management Singapore,

Rocky horror picture show

To say that the month has been unsettling for markets is an understatement. While risk sentiment improved somewhat over the past week following the bazookas shot on the fiscal and monetary policy fronts by an expanding list of countries, global markets are still firmly in the red on a year-to-date basis. Market volatility has not abated, with major market benchmarks swinging wildly during trading.

The Chicago Board Options Exchange (CBOE) volatility index (VIX), typically referred to as Wall Street’s “fear index”, continues to trade well above 60, far higher than the yearly averages seen over the past three years. At one point, the VIX surged to a record close of 82.69, exceeding the previous peak of 80.86 reached on 20 November 2008 in the throes of the Global Financial Crisis. Clearly, volatility has returned with a vengeance.

Market turbulence is not just confined to equity markets. Measures of volatility in interest rates and currency markets have surged as well. Meanwhile, credit spreads have widened significantly, pricing in higher default risks as the global economy grinds to a halt following enhanced efforts by governments across the globe to contain the Covid-19 pandemic.

Commodity prices have also tanked owing to the grim global demand picture and the ongoing oil price war between Saudi Arabia and Russia. Indeed, the period of extreme volatility likely signals that markets are bracing for an impending global recession and reacting to heightened risks of a potential financial crisis.

Policy makers leap into action

Fortunately, policymakers have responded to the crisis swiftly and substantially. Global central banks have cut interest rates to crisis era lows, relaunched once-dormant asset purchase programmes and injected massive amounts of liquidity to lubricate faltering markets.

Meanwhile, fiscal authorities have reached for their proverbial cheque books to dole out generous amounts of cash to households gravely impacted by the economic fallout from the pandemic shock and to backstop ailing businesses with a mixture of loans and grants. The breadth and depth of government support announced in the span of weeks is utterly staggering. But given the unprecedented nature of the crisis, dramatic action is necessary.

Take the US for example. The recently passed US$2 trillion coronavirus rescue package, which is equivalent to 10% of US GDP, is the biggest stimulus package in its history and appears large enough to plug the sizable hole in lost output from 5 weeks of no production or 10 weeks of 50% production. On absolute terms, yes, US$2 trillion is a staggering amount. But as a proportion of GDP, European countries have announced far larger expansionary fiscal packages.

These policies offer significant help for affected households to meet their financial obligations for the next few months as containment efforts get underway. Meanwhile, lending programmes to small and large businesses should keep these companies afloat and solvent through the crisis. Such lending programmes also attach conditions requiring companies receiving these loans to keep their workforce intact, which might help to save jobs and mitigate the rise in unemployment.

Looking forward, market developments will likely be determined by:

  1. How successful containment policies are in bringing the pandemic under control,
  2. How quickly economic activity can return to normal after cases have peaked and
  3. How effective monetary and fiscal responses are in limiting the near-term damage wrought by the economic shutdown and collapse in global demand.

Crisis in context

The worst is certainly far from over. The daily number of confirmed Covid-19 cases continue to rise globally, primarily driven by higher counts in the US and Europe. A second wave of imported cases is a new source of worry for China and other countries in Asia, which have mostly contained local transmissions.

Meanwhile, the continuous drip of anemic soft and hard economic data does not particularly inspire confidence. Flash composite Purchasing Managers’ Indices (PMIs) across the US, Europe and Japan have sunk to record lows in March, while the US, Canada and other European countries have reported a spike in claims for unemployment benefits. In particular, initial jobless claims in the US surged to over 3.28 million for the week ended 21 March (vs. 211,000 the week before), quadruple the previous record since these numbers were published in 1967.

Yes, recent data and forecasts suggest that the impending global recession might be a very deep one. Yet, it is also important to note that the current slowdown is quite unique in nature, primarily because segments of the global economy are virtually shut down, almost synchronously, while containment efforts pick up. Swaths of the global population are confined to their homes, making consumption, production and investment in some sectors nearly impossible. And this is by design, as countries are scrambling to eliminate the virus threat.

Importantly, the nature of this virus shock is likely to be seasonal rather than permanent. As such, the impending global recession, while extremely deep, might also be one of the shortest. In the absence of precarious systemic imbalances, the recovery from this crisis might not be as weak and laboured as one following the 2008 Global Financial Crisis.

Indeed, the virus shock has triggered one of the fastest and sharpest market corrections in history. Stock markets sunk about 30% in a matter of weeks. But it has also led to one of the most dramatic global monetary and fiscal policy responses in history. Considering that the virus shock is likely to be a seasonal factor, as opposed to a persistent, systemic problem, the likelihood that asset prices will recover sharply after the Covid-19 crisis abates is fairly significant. Ultra-loose monetary policy settings comprised of record low interest rates and unprecedented quantitative easing will act as an accelerant to the recovery of asset prices once the crisis blows over.

Stay invested

The problem is timing the bottom of the virus-induced sell-off. As it stands, the situation remains uncertain and fluid, which makes the effort of predicting the bottom a fool’s errand.

Investors are better off staying invested and nimble in the current market environment. For those with a mid to long-term investment horizon, the correction in equity and credit markets presents an opportune time to accumulate quality assets on the cheap. Given the current turbulence, investors should stagger their market entry and ensure they have plenty of dry powder left to ride out the volatility and deploy liquidity when tactical opportunities arise. Indeed, for these investors, perhaps it is best not to let a bear market go to waste.

Still, even as investors scout for opportunities in this volatile market, they should always observe the discipline of managing risks by reviewing their portfolios regularly, trimming exposure to sectors that are directly impacted by the crisis and positioning investments for the possible rainbow while sheltering themselves from the current storm. In this regard, we cannot stress enough the importance of diversification to ride out the market volatility ahead.

The wisdom of diversification in volatile times

When it seemed as if markets could only go higher with the emergence of growth green shoots at the beginning of the year, tracking a market index might have appeared to be the most straight-forward option. With those expectations flung out of the window, market volatility has returned with a vengeance. As the market environment continues to remain turbulent and bumpy, a passive investment strategy might not be the best option to ride out markedly higher volatility ahead.

Amid unprecedented volatility, active management, agility and asset diversification are crucial to generate returns and mitigate losses. Experienced fund managers, with access to deep resources, might be better positioned to steer portfolios through such heightened turbulence and rapidly changing market conditions, whilst still being nimble and flexible enough to capture market opportunities as and when they arise.

Multi-asset strategies that are invested across multiple regions and asset classes are useful in this regard. “Don’t put all your eggs in one basket” goes a familiar investment adage. Diversification is a good strategy for investors looking to reduce risk and increase stability of their portfolios as they ride out and navigate the volatile environment ahead. Spreading out risk across different asset classes that are ideally uncorrelated with one another could help mitigate the adverse impact of rocky market conditions on their investment portfolios, whilst still ensuring participation in any subsequent market upswing.

The standard merits of diversification during volatile periods, characterised by steep declines in the broader markets, are borne out in the data.

Comparing the performance of various multi asset strategies against the MSCI All Country World Index year-to-date, we find that on a total return basis in US Dollar-terms, the MSCI All Country World Index fell about 22.4% whereas multi asset strategies declined by about 13 to 16%, an outperformance of about 6 to 9%. Clearly, past performance data supports the view that diversification helps to mitigate downside risks in turbulent conditions.

The same inference applies when comparing the cumulative total returns of the same multi asset strategies against the global equity benchmark in the last quarter of 2018.

As many would recall, the fourth quarter of 2018 was fairly tumultuous, as markets fell on heightened recession risks on account of the Federal Reserve’s monetary tightening and escalating trade tensions between the US and China. Global stocks fell about 13% on a total return basis during the quarter. Yet, over the same three months, multi-asset strategies outperformed the equity benchmark by 8 to 10%.

While multi-asset strategies may sacrifice some potential upside due to less concentrated exposure to equity markets when times are good, they are certainly useful in mitigating the downside risks when times are bad. This is a trade-off that has to be made. We saw market volatility spike periodically in 2018 and 2019, and as Chart 8 shows, multi-asset strategies were able to ride out these volatile periods with less fluctuations.

Ultimately, diversified and actively managed instruments like multi-asset funds offer investors a convenient and straight-forward solution to manage their downside risks, especially against a background marked by substantially high turbulence and uncertainty.

It is also a cost-effective approach to gain exposure to a broader set of asset classes and regions within portfolios.

With volatility unlikely to ebb in the foreseeable future, these strategies might play an important role in anchoring portfolio returns and alleviating downside pressure. Nevertheless, investors should still be mindful of the risks that come with investing. Investment performance of funds might still be adversely impacted during periods of serious market stress.

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