11 June 2020

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  • Equity markets experienced the sharpest drop since the global financial crisis amid shuttered businesses, decimated consumer confidence, and unprecedented uncertainties about the outlook.
  • Markets were “disrupted but not derailed,” due to swift actions from governments and the major central banks, and with policy responses informed by lessons from the financial crisis.
  • Having moved to a neutral stance on equities in the fourth quarter of 2019 due to high valuations that left little room, we turned positive later and remain constructive and selective in our portfolios, seeing areas with attractive return potential.
  • The market inefficiencies we’re seeing today create fertile ground for stock selection and make a strong case for active investing in order to tap potential alpha.
PineBridge 2020 Midyear Investment Outlook

While it may be hard to believe for anyone who has lived through the past few months, equity markets are at about the same levels they were in late November of 2019, when we were contemplating our outlook for 2020.

The S&P 500 Index was reaching new highs as the year wound down, spurred in part by the possibility of a de-escalation of tariffs as part of the Phase 1 trade deal between the US and China. Adding to the optimism in financial markets were rising new orders for capital goods, which signaled that the US industrial downturn may have bottomed, and continued robust US consumption growth.

The months that followed were a rude awakening, with equity markets experiencing the sharpest drop since the global financial crisis (GFC) as the coronavirus pandemic shuttered businesses, decimated consumer confidence, and created unprecedented uncertainties about the outlook.

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Following the initial sharp drop in equities at the end of February, our view was that markets were likely to be “disrupted but not derailed.” Despite the heightened macroeconomic uncertainty, we expected the exogenous shock from the global pandemic to be met with swift actions from governments and the major central banks, with lessons from the financial crisis informing policy responses. Chief among them was the importance of removing the ‘tail risk’ to stabilize markets. When much of the global economy shuts down, the specter of a depression as the worst-possible outcome, or the “tail risk,” returns and may even loom larger than in the 2008 housing market collapse.

We identified three necessary elements in what history might call the Bernanke-Geithner Axiom of Economic Crisis Management: 1) act fast, 2) ensure that the central bank and Treasury act in tandem, and 3) go big – with a solution that significantly exceeds the scale of the problem in order to be credible to markets. And that is essentially what we’ve seen.

The Fed indeed acted fast to push rates down to close to zero and made asset purchases that dwarfed those during the GFC period in just days. In a matter of weeks, it had increased the size of its balance sheet to a new record high, restarted GFC-era special liquidity programs for the financial system, and perhaps most importantly, activated section 13(3) of its charter, which allows the Fed to lend broadly to the economy by supporting short-term commercial debt. Meanwhile, the US Treasury’s relief plan (amounting to about 10% of US GDP) also set new records, both in its size and in the rapidity with which it passed.

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Markets will also continue to trade on new-case data for the coronavirus. We see an analogy here to investing in bank stocks through an economic cycle, where the increase in non-performing loans (NPLs) is tracked carefully: The market is forward-looking and does not buy on the change in NPLs, but rather the rate of change. If the number of new cases is levelling out, the rate of change is trending toward zero, and becomes a positive sign for the future.

Worries about a second wave of infection are increasingly being offset by advances in potential treatment options and vaccines – especially the latter, with hopes growing that a vaccine could be available as early as this year. More clarity on treatments or a vaccine could be a key driver of the pace of demand recovery globally and among sectors, and may also reduce the depth and duration of damage to our economy – and in turn be favorable for equity markets and risk appetite.

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Having moved to a neutral stance on equities back in the fourth quarter of 2019 due to high valuations that left little room for further increases in expectations, we turned positive later in the spring and remain constructive, seeing areas with attractive return potential, although we continue to be selective in our portfolios. The market inefficiencies we’re seeing today create fertile ground for stock selection and make a strong case for skillful active investing to tap potential alpha.

Amid coronavirus-related uncertainty, market views on the outlook for companies have varied dramatically, creating unusually wide dispersion in earnings per share (EPS) estimates. And the dispersion is broad-based: while US companies typically show the least dispersion and Asian companies the most, companies everywhere are facing a high degree of uncertainty in the current environment.

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We believe 头条军事the removal of the worst tail risks头条军事 through aggressive policy action, along with greater optimism about treatments and vaccines, have allowed investors to be more forward-looking. We are finding attractive investment opportunities across a variety of countries and industries with a prevalence in technology, industrials, and those where we have strong confidence in the management team. 

Broadly speaking, the market is underweight equities, and we see opportunities for active managers as differentials between companies continue to rise. Given the spike in the range in earnings estimates that has occurred across all markets – including the US, which tends to be among the most efficient – combined with a sharp uptick in return dispersion, we believe the risk-reward is attractive for fundamental investors with a medium-term investment horizon.

Most of the actions the Federal Reserve and the Treasury have taken (or will likely take) have already been incorporated into stock prices, given the ongoing expansion in valuation multiples we’re seeing. While visibility is limited into the pace of demand recovery and the possibility for permanent changes in parts of the economy, we see the potential for the fittest companies – those with strong management teams and strong balance sheets – to improve their relative advantages and to gain disproportionately.  

One area that hasn’t changed since the beginning of the year is our focus on next-generation management and the power of digitalization – a process by which companies are capturing data and performing analytics to drive increases in revenues, margins, and profitability. Unlike the standard management practices of becoming lean, optimizing supply chains, doing a few bolt-on deals to increase scale, and fixing balance sheets where needed, next-gen management teams can transform a company from being good or even very good to great. Critically, next-gen management can be found in any industry and is independent of the company’s maturity, and finding stocks with next-gen management that are early in the transformation process may be a very attractive source of alpha in portfolios. We have also found anecdotally that companies with this management approach may be faring better in the current crisis due to their more adaptive and forward-looking models.

All told, while we expect volatility to remain elevated amid shifts in news and sentiment, we think it’s a great time now – and opportunistically as the markets move – to invest in the world-class companies of both today and tomorrow.

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