Pitfalls & Pitch calls: Poking the bear

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on May 11, 2020 - May 17, 2020.
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You would probably have heard; we are in a bear market. Months of prophesising that risk assets would continue their steady ascension in 2020 were washed away by the sudden appearance of Covid-19.

As containment measures are ramped up, markets have become disenfranchised with the idea of holding on to risk assets, moving instead to cash. Assurance from experts that the short-lived recession will eventually give way to a market recovery has not convinced many.

As such, why should you start taking positions in this market or, at the very least, stay invested?

The first question to ask is: How long can cash stay king? This environment of benign inflation is set to change, with central banks pumping trillions into the world’s financial plumbing by lowering interest rates and through direct cash injections. Factoring in more potential interest rate cuts by Bank Negara Malaysia this year and possibly in 2021, and the 1.7% inflation rate reported for January — the effective return to depositors is less than 1% on an average fixed deposit rate of 2.79%. Cash instantly becomes a king who yields lower returns.

Although we are facing a recession in 2020, we see a case to engage with markets — recessions are a rebirth opportunity. During a recession, our economic system sifts out bad businesses and allows for the reallocation of capital to new and innovative businesses.

Equities will continue to be the key risk vehicle for investors looking to build wealth, but engaging in this market will require a fisherman’s patience. Returns will not come at the year-end or even the next year, but over the next three to five years.

Investors ought to complement their portfolios with assets that generate income such as Asian bonds/bond funds. With strong government support and exposure to domestic consumption, these issuers are set to benefit from Covid-19 pandemic support policies and the relatively shorter time it will take for some sense of normality to return — as is evident in China and South Korea.

As investors attempt to position for a recovery, we offer three signposts to watch out for to guide cash deployment.

First, we would welcome signs that indicate infection rates at key hotspots have peaked and infection rates across the world are showing signs of stabilisation, and in some cases slowing. This will help us gauge how much longer constraints on the economy will remain. China and South Korea were among the first countries to seriously act on the virus and they have been reporting manageable infection rates since the peak. As these Asian economies restart, the pick-up in demand will provide some certainty for the markets’ base case of a very deep but rather short-lived recession.

Second, watch out for the expected virus resurgence and resulting containment measures. The base case of a short recession is predicated on the hope that containment measures will be lifted soon and wide-ranging monetary and fiscal stimulus will deflect economic damage, allowing some semblance of normalcy from July. This scenario will come to be only if the risk of a resurgence is successfully managed by policymakers.

China has clamped down hard on the second wave of infections, quarantining a whole county after a woman became sick following a visit to a doctor who carried the virus without symptoms. A cycle of repeated lockdowns as Covid-19 returns will have devastating consequences on the economy. Monitoring the downside risk of a resurgence will play an important role in managing risks.

Lastly, observe stimulus buffers. Government support so far has helped offset shocks to businesses and the labour market, but is unlikely to be able to stave off a longer slump, resulting in a downward spiral of falling corporate earnings, surging unemployment and collapsing consumer demand.

More stimulus from policymakers would help build up additional buffers for businesses and consumers. Governments around the world have announced over US$4 trillion (RM17.3 trillion) in fiscal stimulus measures, which include cash handouts, wage subsidies, stop-gap financing, grants to small and medium enterprises, temporary loan deferments and the loosening of regulations to tap into new sources of funding.

It is important that policy actions respond to any future extension of lockdowns and control orders. Responding to negative developments with further support measures will ensure that consumers and businesses are in a state of health that allows economic recovery to take place when the time comes.

We are not delusional optimists; the world will need more than a few months to recover from the Covid-19 pandemic. Even then, a post-Covid-19 world may never be the same again. But that does not mean opportunities have been extinguished — watching these signposts will give you some clues on how to engage the market in 2020. In the meantime, until we have proven treatments or a vaccine, the tale of caution must continue.


Michael Lai is vice-president of wealth management research at OCBC Bank (Malaysia) Bhd