Review & Outlook

Logic & Architas

With so much changing across global financial markets, it’s good to get a range of opinions. Here’s Jaime Arguello, Chief Investment Officer of Architas, to share his thoughts on the first quarter and give an outlook for the months ahead.

We turned to Jaime Arguello Chief Investment Officer of Architas, to share his thoughts on the first quarter and give an outlook for the months ahead.

The beginning of 2020 has been marked by the Covid-19 pandemic, the stock market (equity) sell-off and rebound, as well as weighty responses from governments and central banks in terms of support packages. These stories have been widely reported, so we look at some other stories over the quarter.

In brief

* The oil price war between Russia and Saudi Arabia accelerated the market downturn in March. Since then a deal was agreed to cut oil production to boost crashing prices. However, demand remains very weak, so the impact has not been as expected. In addition, storage issues have added to the downside price pressure.

* Within equities, and although we maintain a defensive stance, we are tactically shifting some of our exposures from US equities to Asian equities. The US has seen the strongest rebound so Asia offers good value on a relative basis in the short term.

* We have decided to increase allocation to corporate bonds including higher risk and lower risk areas of the corporate bond market (high yield and investment grade bonds). This is on the back of very strong support from central banks.

Our view

Could you explain the recent developments in the oil markets? There has been an oil price war between Russia and Saudi Arabia, which accelerated the market downturn in March to the lowest levels in nearly twenty years. Since then we have had an agreement to cut oil production, by nearly 10 million barrels a day, in a bid to boost crashing prices. However, demand remains very weak, so the impact has not been as expected. In addition, storage issues will add to the downside price pressure.

Just an added word on these government and central bank support packages, it’s worth noting that they continue to be supplemented by additional measures, almost on a weekly basis. The speed of these announcements has reassured investors, hence the rebound in the last couple of weeks.

We have increasingly heard references to ‘fallen angels’ in the corporate bond sector. Could you explain that term to us? The term refers to company credit (debt) or bonds that lose their investment grade rating (bonds rated BBB- and above) and are downgraded to high yield (BB+ or below). Recently over $1 trillion of company debt has moved close to this point in the corporate credit space, and this creates a lot of volatility in the markets. In many cases, investment grade companies will be big companies with a lot of bonds and when they come into the high yield market, they create a bit of turbulence.

Looking forward, what are the biggest risks for markets now in 2020? The obvious risk is that lockdowns are maintained for much longer or are reinstated after being relaxed. From one angle, governments can support a short recession, but cannot possibly maintain such a level of support for many months. So clearly, the proper balance has to be managed to avoid a deep depression globally.

The US economy has clearly suffered a setback – although the extent of this is still unclear – could this have an impact on the US election? This is a very difficult issue as we do not know the potential stage of the recovery in Q4. This will impact the opinion polls and Trump’s ratings. It’s fair to say that the handling of the sanitary crisis from the US has been quite poor. However, the stimulus measures have been significant. The key will now be the implementation of these plans, as the current framework for these state aid programmes is not in any way designed for the volumes of applications from both businesses and individuals. This could impact Trump’s rating, which is currently around 50:50, but of course, this could materially change over the next six months.

What are the main opportunities for the rest of this year? In normal market environments investors can make reasonable forecasts, based on known variables. In this case, however, there are a number of variables, in particular the medical variables, that are extremely difficult – or even impossible – to forecast. It is interesting to note that in the current environment the range of economic and financial forecasts is wider than ever and these forecasts are revised on a weekly basis. So there might be some opportunities, but in this context they need to be re-evaluated on a continuous basis.

Could you throw some light on our latest tactical asset allocation moves? Around mid-March the equity allocation in our portfolios moved lower, as markets fell, and we have now decided to add to equities to adjust for this.

Most recently, we have decided to add to some bond sectors, namely corporate bonds including higher risk and lower risk areas of the corporate bond market (high yield and investment grade bonds). And this is clearly on the back of very strong support from central banks. This support reduces the risk of further sell-offs in corporate bonds, Investors have worried about corporate defaults, as indicated by widening spreads (the spread measures the difference in yield between government bonds and other debt securities of lesser quality, such as corporate bonds). Although these spreads are lower than the widest reached in March, they are still attractive on a medium term perspective.

Within equities, and although we maintain a defensive stance, we are tactically shifting some of our exposures from US equities to Asian equities. The US has seen the strongest rebound from the lows – around 25%, while Asia has seen a much more modest recovery – around 16%. In Asia, there are a number of countries that seem to be in a more advanced stage of the contamination control. So Asia offers good value on a relative basis in the short term. We will monitor this very closely and adapt as market conditions evolve.