Cover Story: Don’t panic, stay invested

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on March 16, 2020 - March 22, 2020.
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Fears over the Covid-19 outbreak and the recent oil price crash have gripped financial markets around the world, reigniting concerns of a global recession. Amid the price plunge across bourses, it is crucial that investors do not panic but adopt strategies that can generate income as they await a recovery from these events, say the fund managers interviewed by Personal Wealth.

These events should be seen as transitory, they add. This view remains even as the coronavirus outbreak and oil price crash come at a time of slowing economic growth and jittery markets impacted by geopolitical tensions last year. 

“If you look at history, every kind of epidemic or pandemic events are transitory, whether it is SARS (Severe Acute Respiratory Syndrome) or the avian flu. If you look at the SARS outbreak in 2003, the markets recovered within six months of the event,” says Principal Asset Management Bhd chief investment officer Patrick Chang.

For example, the S&P 500 and Hang Seng Index fell 10% at the onset of the outbreak, but rose 26% and 35% respectively by the end of the year, according to his research. 

The recent fall in oil prices is a self-induced shock, according to David Ng, deputy managing director and chief investment officer at Affin Hwang Asset Management Bhd. “It is a self-induced supply shock rather than a sudden collapse in demand, which is more detrimental to the economy,” he says.

“Viewed through a wider geopolitical lens, the move by Russia is seen as a strategy to weaken shale players and hurt the US economy, beyond just gaining market share. We expect further pain ahead for oil markets before any Opec+ countries can be brought back to the negotiation table.”

Of course, with regards to the impact of Covid-19, China’s role in the global economy is now bigger than in 2003. Many data sources show that the country’s manufacturing activities are not back to normal yet. This has disrupted global supply chains and consumption patterns, with companies such as Apple and Starbucks issuing revenue warnings.

“Import demand from China makes up 2.4% of global GDP today compared with 0.4% in 2003. As such, a weaker Chinese economy today will undoubtedly affect the global economy, more so than in 2003,” says Ng.

Nevertheless, he believes the negative impact on economies and stock markets will be transient due to the swift response of policymakers to contain the impact of the outbreak. For example, China immediately took unprecedented steps to impose a lockdown in infected areas. Fiscal stimulus packages were announced by various governments and interest rates were lowered by central banks in the last few months.

“We think the global economic recovery risks being delayed rather than derailed. The quick and measured response from the Chinese authorities in containing the outbreak has soothed fears, as the authorities draw upon lessons from previous outbreaks such as SARS and MERS [Middle East Respiratory Syndrome]. While we could see the impact on China’s 1Q2020 GDP, additional fiscal and monetary support may cushion downside to its economy, albeit with a lag effect,” says Ng.

It is impossible for economists or investors to forecast when this episode will end. But many economists are using previous outbreaks, which peaked between one and six months, as an example.

“We think this may be contained by the end of spring in the northern hemisphere, which is after March. This is the primary scenario assumed by most economists, including ourselves, that come spring, the outbreak will taper off,” says Danny Chang, head of managed investments and product management at Standard Chartered Malaysia.

Transitory, but do not discount the risks

Earlier this year, the virus outbreak took the baton from the US-China trade war to become the key source of market volatility. By end-February, it had wiped US$6 trillion off global markets in a week, according to reports, sending the S&P 500 into correction territory and reigniting fears of a global recession.

The managing director of the International Monetary Fund said earlier this month that the continued spread of Covid-19 would push 2020 global growth below that of last year and that the organisation would revise its forecasts downwards in the coming weeks.

Adding to the bad news is the failure of the Organisation of Petroleum Exporting Countries (Opec) and Russia to agree on deeper production cuts. This saw Brent crude oil prices tumbling to US$31 per barrel on March 9, the lowest since 2016. Consequently, this triggered a global equity rout, sending US stocks to their biggest decline since the 2008 global financial crisis. On the home front, the FBM KLCI closed 58.94 points (3.97%) lower at 1,424.16 points on March 9.

While the number of new Covid-19 cases in China is declining, the opposite is true outside of the country. That is why investors should keep in mind that the outbreak is still developing. It will negatively impact economies and markets across the globe, at least for the next few quarters.

“Just before end-February, equity markets around the world still held the assumption that there would be some kind of rebound in economic activity in the second quarter. That was before the equity market correction in the last week of February, which put the assumption to test. Clearly, the market is beginning to factor in the possibility that the implications will spill over to the second quarter,” says Danny.

“At the moment, new outbreaks outside of China continue to rise. That is why the market is reacting this way. Looking at the number of new cases versus the rate of recovery outside of China will be crucial. I think that is the key indicator every economist will look at.”

Meanwhile, in Patrick’s view, markets have already priced in the possibility of lower growth in the first quarter. Investors may see some corrections in the second half of the year if economic growth continues to suffer. But he believes that China’s government will immediately react to stimulate the economy.

“It will not let its GDP drop below 5% because it is too much risk to the economy. It has 1.4 billion people to feed, so it has to simulate the economy. That is what it did during the SARS outbreak and global financial crisis,” says Patrick.

In his opinion, the global economy will recover in the second half of the year if policymakers take swift action to support the economy and markets. Regardless, investors will need to prepare for weaker numbers in at least the first two quarters of this year.

Will there be a global recession as a result of these events? It is not likely, according to the fund managers. There are no major bubbles built up in asset classes and the global economy was already in gradual recovery in late 2019, according to the manufacturing and services Purchasing Managers’ Index data.

“The world economic growth seems to have bottomed out before the occurrence of Covid-19. The likelihood of a recession caused by this is not substantial, given that there is no significant deterioration in the fundamentals currently and there is continuous support from governments and central banks. Thus, we have kept the global growth outlook unchanged at 3.3% in 2020 and 3.4% in 2021,” says Michael Lai, head of research (wealth management) at OCBC Bank Malaysia.

A sharp recovery is unlikely, but economic activity is expected to improve moderately into 2021, he adds.

Go for Asian equities

Investors should have a diversified portfolio with yield-producing assets, says Patrick. He is bullish on equities, recommending a 60:40 ratio of stocks to fixed income. This view is driven by the compelling valuations of equities in Asia. Last year, he recommended a ratio of 50:50.

“This is the year of equities while last year was a combination of equities and fixed income. Bond yields have come down and we think a lot of rate cuts have been factored into bond prices [which are high]. We suggest that customers shift their portfolio towards more equities and buy more global or high-beta equities such as Chinese or global technology equities. In our core strategy, we like global real estate investment trusts (REITs), equity portfolios or balanced income portfolios,” says Patrick.

In the equities space, he is more positive on Asian versus developed market stocks. China, Singapore and Indonesia are among his top picks.

“I think China is cheap right now. It represents about 35% of the [emerging market] benchmarks. So, if China does not rebound, it will be tough for Asia to rebound. If you get China right, you will get Asia right,” says Patrick. 

Asian equities can give more upside than its US counterparts, which are not cheap currently, he adds. “Singapore equities are not very cheap, but they give you a lot of yield and are quite defensive. Indonesia is a classic example of a big economy whose government is very serious about pump priming.”

In a February note, JP Morgan observed that the market fundamentals for investing in China remained sound, with vast potential for growth in the healthcare, consumption and technology sectors. These sectors are closely tied to the country’s long-term economic development.

Morgan Stanley also upgraded the stocks of China, Singapore and Australia this month as it expects further policy stimulus and relatively cheaper valuations. It chose to overweight China and Singapore while rerating Australia from underweight to equal-weight. According to its report, the bank is “boosting positions for defence or quality and incrementally for stimulus beneficiaries”. 

The long-term trend of the supply chain relocation out of China into Asean also contributes to Patrick’s views on the region. This will benefit industrial estate players and selected manufacturing companies.

Patrick likes technology counters in Asia due to the developments in 5G telecommunications technology. Meanwhile, he remains cautious about the tourism and aviation industries, which were hit hard by Covid-19. Conversely, glove makers and healthcare companies, which have benefited from the outbreak, are still interesting due to the long-term demand for their products.

“There are a lot of opportunities, whether it is a global or Asia-Pacific equity portfolio. I think the priority for us in equities is Asia first, followed by global REITs, Asean and Malaysia, then the rest of the world,” says Patrick.

The preference for global REITs is due to their exposure to many geographies and ability to behave like equities while providing income. “Over the last decade, global REITs have outperformed a lot of asset classes, with very high single-digit US dollar returns. The beauty of global REITs is that you have an equity-like product with a steady income flow,” he says.

Is it a good time to look at equities in the US, where prices fell last month after a strong run? Lai sees reason for caution. “This includes the enforcement of intellectual property protection in China, potentially tighter regulations against Huawei, as well as the bear case scenario of a prolonged Covid-19 outbreak,” he says.

“Under such a scenario, we may see some pressure on big tech names. Rich price-earnings multiples leave limited room for meaningful expansion while consensus earnings per share estimates should moderate into the year.”

Meanwhile, there is upside potential for Europe as the valuations are not as extended as its peers, says Lai. “But we are cognisant of the risk that the US may be turning its sights to Europe in terms of more tariffs. Negative news on this front may drag investor sentiment, especially for auto sectors impacted by any imposition of tariffs.”

Danny is positive on US technology counters due to a rebound in semiconductor demand and growth in cloud computing. He also has a constructive view on the financial sector across the US and Europe, due to share buy backs and exemptions from negative interest rates in parts of Europe.

Financials in Europe, in particular, could benefit from a weaker US dollar. While the latter is not the case right now, expectations of narrowing bond yields versus other major currencies and further rate cuts could result in that situation over time, Danny observes.

By March 10, European stocks had recouped a little less than half the losses they saw the day before, which was the biggest fall since 2008. According to reports, Amundi SA, Europe’s largest asset manager, believes that the markets have turned overly pessimistic. In the longer term, stocks in the region could get a boost from fiscal intervention and monetary easing by the European Central Bank. 

Strategists at several investment firms in the US support the view that further fiscal and monetary stimulus in the US and Europe will stabilise financial markets soon, resulting in a recovery for equity markets. However, volatility is expected to remain in the meantime.

Protection while waiting for recovery

Bond yields are low across the world now. But this asset class should still play a part in portfolios by giving investors a level of cushion while they wait for a recovery, says Danny. This is even as bond yields are expected to decline further with more rate cuts on the horizon.

“When interest rates come down, bond prices typically appreciate. That is what is happening right now. In a way, we are following bonds less for the yield than for short-term capital gains. The bonds give you a coupon — albeit a small one — and potentially some capital gains while you wait,” he says.

One way of using bonds in a portfolio is by investing in high-yield bonds, especially those in Asia. “These bonds are now yielding in excess of 6% to 7% [based on the actual benchmark for non-investment-grade corporate bond yield to maturity as at March 6]. If you look at the market cycles for high-yield bonds in Asia, they typically behave very much like Asian stocks. It is like a proxy for Asian equities,” says Danny.

Investors who do not want to go all in into Asian equities can invest in Asian high-yield bonds to enjoy growth while still receiving a steady income, he adds.

Go for an income strategy

The fund managers hold the view that a multi-asset portfolio is important for investors in this volatile landscape.

Ng believes investors should not do much on the back of events like the Covid-19 outbreak and instead, stick to their long-term asset allocation. “However, one should ensure that these are stocks investors are comfortable holding for the long term. We do not agree that investors should chase some of the stocks that are already expensive, like those in healthcare,” he says.

In this late-cycle economy, investors should adopt a barbell approach to positioning their portfolios, says Ng. This means having dividend anchors that will provide a buffer to the portfolio, which could be a mix of cyclical and dividend players.

In addition, there should be a focus on companies that can provide a measure of stability and hold up well through market declines. In this context, it could be large, liquid and high-quality stocks that have the potential for structural growth.

“We do not see meaningful winning or losing sectors when Covid-19 eventually recedes. From another perspective, highly indebted companies may struggle tremendously to service their debts and interest payments. On the other hand, it could be a blessing in disguise for companies with strong balance sheets because their highly indebted competitors may not survive the temporary economic slowdown,” says Ng.

Similarly, Lai suggests that investors consider an income strategy according to one’s risk appetite, comprising fixed-income assets, dividend-paying blue chips and gold. “Diversified portfolios are more likely to generate better risk-adjusted returns in a year that we expect to be characterised by a wide dispersion of performance across different companies and sectors,” he says.

“It is probably wise to consider having some income-generating assets to provide consistent cash flow that serves as a buffer in the volatile investment environment. And it would be great to have some exposure to gold for portfolio diversification to hedge against any unexpected developments of the virus.”

Lai also suggests that investors avoid industries directly impacted by the outbreak, such as travel, hospitality, restaurants, retail and entertainment. As equities are at full valuations across regions, he is neutral on those in the US, Europe, Japan and Asia ex-Japan, overweight on stocks in Singapore and neutral on Malaysian equities. “We recommend switching from high-beta names into steady dividend-yielding stocks such as Singapore REITs,” he says. 

In fixed income, he is overweight on emerging market (EM) high-yield bonds. “With EM high yields, we prefer Asian high yield, especially in the Chinese property sector, where our view remains constructive over the medium term, underpinned by real demand and monetary easing by China’s central bank.”

Triple whammy for Malaysia?

Investors in the Malaysian market are advised to review their asset allocations in response to mounting risks and diversify their holdings to include foreign assets, say fund managers.

That is because uncertainties abound in the local market. Before the Covid-19 outbreak hit the country, the economy was already slowing down, with 4Q2019 GDP growth the slowest in a decade.

Then, late last month, political turmoil and the abrupt change in government caused the FBM KLCI to drop to its lowest since 2011. The third blow came this month with the oil price crash. 

With the breakdown in communications between Opec and its allies (Opec+), oil prices are likely to stay lower for longer. According to a research note by CGS-CIMB, a US$13 decline in oil price assumption could mean a fall of RM4.5 billion in oil-related revenue, resulting in a net impact on Malaysia’s fiscal deficit of RM2.7 billion, or 0.2% of GDP. The deficit is widened to 3.6% of GDP, compared with 3.4% in 2019, when combined with the fiscal stimulus package.

Bank Negara Malaysia has already cut the overnight policy rate twice this year to support the country’s economic growth amid the Covid-19 outbreak. Economists are expecting more to come. Consequently, this will hurt many Malaysians who use fixed deposits to save for retirement.

“Prior to the January rate cut, fixed deposit interest rates were about 3.5%. At that rate, it would take 21 years for depositors’ money to double in value on a compounded basis. The reduction to 3% in January will add three years to that number,” says Danny Chang, head of managed investments and product management at Standard Chartered Malaysia.

“Malaysians will have to work their deposits a little harder by mobilising some of these into risk-taking assets, like bonds, which could potentially yield higher returns. Assuming a moderate yield of 4% per annum, the time required to double the deposits’ value on a compounded basis would be reduced to 18 years from 24 years.”

Protection from risks and buying opportunities

In the light of the market volatility, investors should revisit their asset allocations and decide how much risk they can stomach. Those who want to de-risk their portfolios can consider a higher allocation to fixed income, says David Ng, deputy managing director and chief investment officer at Affin Hwang Asset Management Bhd.

“This would hold up better in this environment due to its more modest drawdowns compared with equities. However, over the long term, investors should continue to have some exposure to equities at a level commensurate with their risk profile,” he adds.

The secondary impact of the oil price crash resulted in selling pressures on oil and gas bond issuers in the high-yield space. This will impact the tax revenue of the Malaysian government and its target fiscal deficit, observes Michael Lai, head of research (wealth management) at OCBC Bank Malaysia.

“We continue to advocate a multi-asset-class, globally diversified portfolio with an overall income-generating theme. Having said that, we do not believe it is time to start bargain-hunting yet,” he says.

On the contrary, Patrick Chang, chief investment officer at Principal Asset Management Bhd, believes long-term investors could use this opportunity to begin accumulating local assets. “From a fundamental perspective, I am hopeful that policymakers will do what is necessary [to stimulate the economy]. From a technical point of view, history has shown that Malaysia’s markets tend not to underperform three years in a row, if you look at data for the past 20 years,” he says.

Malaysian equity valuations are also cheap relative to their historical mean, at below -1 standard deviation, he adds. A positive catalyst is now key for the market, especially in the light of the political uncertainty.

“Until such uncertainty dissipates, we will take a defensive stance by focusing on stocks that are resilient to the expected slowdown in the local economy or those that are not exposed to domestic political and regulatory uncertainty,” says Patrick.

He prefers sectors that will benefit from interest rate cuts and earn in US dollars, including consumer staples, healthcare, energy and plantations.

Diversify abroad

But in the bigger picture, the valuations for Malaysian equities, which is at about 16 times price-earnings, are higher than those in other Asian markets, Danny observes. Malaysian corporate earnings growth is also not forecast to be stronger than the rest of the region. “You add the political spin to this and there is an even greater lack of catalysts for rerating in Malaysia,” he says.

That is why investors should ensure that they go beyond home shores as a way to  diversify. For those still invested in Malaysia, Danny recommends going into defensive sectors and dividend-yielding stocks while waiting for a recovery.

“You do not have to plunge fully into stocks. You can take mini-steps and buy into Asian corporate bonds. There are ringgit-denominated corporate bond funds that could yield you 4% to 7%, which is better than your fixed deposits,” he says.