By David Curmi
It has now been over a year since the outbreak of the Covid-19 pandemic. During this time economies have experienced one of the most severe recessions in the history of economics causing bond and equity markets internationally to fluctuate wildly. Meanwhile despite significant job losses, bank deposits have ballooned, as consumers conserve cash through the uncertainty. Is this the time to be putting that hard earned cash to work? If so where?
At the initial stages of the outbreak, investors like anyone involved in running a business were busy trying to assess the potential outcomes and implications of the spread of the virus. Whilst some industries were clearly hit very hard, others, such as technology companies actually benefitted. Similarly, the rush to take cover combined with central banks flushing the financial systems with cash, to avoid a repeat of the 2007/08 crisis, drove yields on high quality bonds to record low levels, and bond prices to record highs. In fact, the universe of negative yielding bonds globally grew tremendously, reaching a peak of USD 18.4 trillion in market value in December 2020 according to the Bloomberg Barclays Global Negative Yielding Debt Index. This reflected the extreme fear that investors held and the central banks’ strong and decisive action to prop up the financial system.
Generally, this trend carried through to 9th November 2020. On that day Pfizer announced the arrival of its Covid-19 vaccine. Suddenly there was hope. Hope that economies could now begin the long road of recovery, slowly putting back the pieces, and this changed the mindset of investors. Suddenly those companies which operated in sectors that were out of favour started to attract investor interest again. Investors shifted from growth stocks (your typical technology company) to value stocks (the more traditional companies). This trend continues as the vaccine rollout takes shape and consumers start to become more optimistic about the near term, expecting a significant rebound in economic activity as spending restarts. For fixed income investors this also may prove to be a major turning point. Whilst central banks continue to insist that they will retain their stance of pumping cash into the financial system, investment markets started, and continue to, price in rises in policy rates. This reflects the expected recovery, as well as some return to more normal levels of inflation. It probably also means an end to ultra-low levels of interest rates, rendering sovereign and high-quality bonds generally an unattractive place to be invested if as an investor you look at your total return.
Where to, therefore? This does not mean that all bonds are unattractive. In fact, there will still be opportunities to eke out positive returns but the era of buying almost any bond and seeing its price rise is unlikely to continue if interest rates are to begin the long journey to more normal levels. Admittedly, still a big if, especially in Europe. Additionally, in times of economic recovery, one would normally look at the equity market as a source of return as companies are able to grow their revenues in periods of economic growth. Yet it is not that equities generally are cheap, but that there are pockets of stocks which, in the context of a recovery, can offer a link into a growing stream of profitability, and for which the price of entry remains acceptable. Investment strategies therefore should be assessed to see to what extent variations ought to be made to take stock of what is probably a new norm in the next phase of markets. Naturally, the ability of each investor to take on this extra risk, needs to be carefully assessed. However, the risk of holding highly priced bonds is also something that will need careful reassessment going forward.
Whilst questions continue to be asked about vaccine roll out strategies, investment markets are looking beyond this and into the recovery phase. It is important therefore that investors reflect this in their thinking. The fact is that, so long as there is not a complete failure in vaccine delivery, or a new variant emerges that cannot be treated by an existing vaccine, then the next phase is indeed going to be the beginning of the long-awaited recovery, and this carries both risks and opportunities.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.