Market Thoughts: The resilience of humanity

Today we are playing active defense. Early-stage recovery is somewhere on the horizon, but we aren’t there yet.

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Market Outlook

  • Markets will likely remain volatile as investors digest the effects of COVID-19 on economies, earnings and default risk.
  • Policymakers have shown their commitment to supporting the economy through this crisis and preventing a recession from becoming something worse.
  • I don’t believe we are seeing a conventional recession. For the next few months, the single most important thing for markets is that investors remain focused on what lies ahead.


  • We actively manage portfolios. Right now, we are playing active defense. There are too many unknowns to be aggressively leaning into risk assets.
  • The two most important positions we hold are our equity underweight and a full duration allocation to core bonds. All of our equity underweight is in markets outside of the United States.
  • We’re no longer “late stage” in the cycle. We’ve just hit reset, we’re in recession. Gradually, investors will begin to shift focus to early-stage recovery. We’re not there yet.

Move fast, don’t break things

I’m in awe of the speed at which U.S. policymakers have been moving when it comes to both fiscal and monetary policy. They learned a lot from having been too slow in responding to the global financial crisis in 2008–2009. Move fast and don’t break things is the policy directive. We’ll reconcile costs later, right now it’s about preventing a recession from becoming something worse. But there’s going to be a bill to pay.

I have never seen a market move at the pace we are seeing currently, or U.S. policymakers act with such force. I wish I could say the same about Europe and other developed and developing economies. Facts—not hope—should drive policy direction and pace, not to mention investment strategy. There is a lot to be said for recognizing what you can’t know in preparing for the worst.

We moved to a significant underweight in equity positions as it became increasingly evident it wasn’t just Asia that was facing a real threat from COVID-19 contagion, but the global economy as well. Any confidence in a quick V-shaped economic recovery faded as COVID-19 began to flare up across Europe and the United States.

We actively manage portfolios, both in how and where we take risk. Right now, we are playing active defense. This event is different from the fourth-quarter of 2018, when we expected equity markets to quickly recover from a panicked year-end sell-off. This is something bad that can get worse. There are too many unknowns at the moment to be aggressively leaning into risk.

The two most important tactical positions we hold across portfolios are our equity underweight and a full duration allocation to core bonds. All of our equity underweight comes from markets outside of the United States. And while there is nothing exciting about core bond yields, high-quality bonds continue to act as an important risk diversifier, helping to cushion portfolios in market drawdowns.

Core bonds are yielding more than cash. Additionally, the optionality they provide as portfolio insurance shouldn’t be understated. There will come a time when it makes sense to shorten portfolio duration, but that will happen when the global economy is in recovery and we begin to see inflationary pressure.

For the next 9–12 months, I am more concerned about stalled global growth and disinflation. Leading indicators including business surveys and consumer confidence data continue to signal that inflation isn’t something to be uneasy about currently.

Unprecedented and historic

Unprecedented and historic seem the operative words for almost everything happening right now. You can only say “bad” in so many ways. I believe we will continue to see as much monetary and fiscal stimulus as needed. Policy easing won’t slow the spread of the coronavirus or directly influence how soon the global economy can be restarted, but it can act as a bridge to help get the economy through this.

The top five U.S. banks have announced over $20bn in initial loan loss and credit provisioning. European banks can’t afford to take the kind of loss provisions we’ve seen in the United States. They don’t have the earnings. The European Central Bank (ECB) has signaled that bank provisioning can assume an economic rebound this year and use ECB economic forecasts made before Europe was put into economic lockdown. That’s troubling.

We’ve begun to see the extraordinarily negative economic consequence of governments putting the global economy effectively into a state of suspended animation. Europe faces a deep recession. We expect to see growth contract by at least 5% this year, but it may end up being as large as an 8–10% contraction. In the United States, I am working with a base case forecast of approximately a 3% contraction this year. Because we don’t know how long the current economic lockdown will continue—or if the virus will return in a second wave—any economic forecast today is at best fluid.

The same can be said about corporate earnings. No one knows, starting with companies, how to give effective earnings guidance. That uncertainty is an important mental marker when you hear someone say equity markets are cheap or expensive. That remains to be proven with 2021 and 2022 earnings.

Worse before better, but then better

It is likely that the current global economic collapse will be the largest since the Great Depression. The IMF said as much when they recently revised down their outlook for global growth this year to a 3% contraction. China announced its economy fell 6.8% y/y in the first quarter, after more than 40 years of uninterrupted full-year growth.

Reflexivity is a term credited to George Soros. The man behind the theory was Rudi Dornbusch. Dornbusch once said: “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” That’s a fair summary of the challenges investors face today in trying to discern the lasting drag COVID-19 will place on the global economy.

I mention reflexivity because I think it’s a concept worth keeping in mind, in particular if markets remain under pressure. The basic concept behind reflexivity is that technicals can, at extreme points, overwhelm and redefine fundamentals. We’ve seen some of that happen already in bond markets.

One of the things that had me concerned about the downside risk across markets was the pressure we saw building in fixed income. That was the case not only across credit markets, but government bonds as well. When you see both equity and bond markets selling off together, as we saw in periods recently, that’s a very strong sign that things are deteriorating quickly. It is an indication that technicals are beginning to overpower fundamentals.

Do whatever it takes and more

I credit recent stabilization across markets to action taken by the Federal Reserve (Fed) to directly support the critical pain points where the fixed income market was under incredible pressure. Mario Draghi was just “upped” in policy gamesmanship by Jay Powell. Do whatever it takes and more. European policymakers should take notice.

The Fed announced a wide range of new facilities to support the flow of credit across the economy. This includes direct support for large cities, counties and states with up to two-year bridge financing should local governments need it.

They announced the Main Street Lending Facility, which will buy small and medium sized business loans, as well as a program to lend against Payroll Protection Program loans being made via banks. That will help free up bank balance sheets to lend to small and medium sized enterprises. More lending is going to be needed.

The Fed broadened the range of eligible assets they will purchase to include investment grade credit that was downgraded to sub-investment grade since March 22 and ETFs in high yield. They will buy AAA-rated tranches of CMBS and newly issued CLOs. That has helped alleviate some market stress.

What lies ahead

The Fed has stabilized fixed income markets. I believe this has reduced the left-tail risk hanging over markets. It wasn’t simply what they did but the fact that they emphasized their commitment is open-ended. As bad as the economic data gets, the Fed views their role as helping to navigate the U.S. economy through this crisis without allowing it to break. That is reassuring investors.

Several weeks ago the downside to equity markets appeared several times greater than the upside. Now, that balance has improved. The Fed cut the extreme left-tail risk overhanging markets. That’s allowed investors to shift attention from fairly violent intra-day equity market swings to looking ahead.

Because of that shift in tail risk, not only have we modestly trimmed our equity underweight but we’ve started to rebuild an investment position in extended credit. We actively reduced risk across portfolios last year as markets continued to climb higher. That included selling out of all high yield exposure. When credit spreads gapped out in late March, we bought high yield credit. We may continue to add to those positions.

Markets are forward looking; hard economic data is backward looking. While recent economic data has generally been worse than expected, investors right now are looking through it. The next month of market trading is going to be particularly important to watch. Equity markets feel ahead of themselves. They’ve moved far, fast.

The dispersion in views around 2020 earnings is less important today because investors are looking through 2020, into 2021 and 2022. There is going to be some dynamic tension introduced into the investor patience equation should markets press higher as data continues to deteriorate.

I don’t believe we have a short and sharp V-like bounce back in front of us for the global economy. I’m going to jump ahead of the National Bureau of Economic Research and say the U.S. economy is in recession. But I don’t believe we are looking at a conventional recession. I say that as good news, not bad. It all depends on when the global economic engine is restarted.

Something interesting happened that hasn’t yet been fully processed by investors. We’re no longer “late stage” in the macro and market cycle. We’ve hit reset, we’re in recession. Gradually investors will start to shift their focus to early-stage recovery. We’re not there yet, but it’s on the horizon.

Earnings matter, so do valuations. But for the next few months, the single most important thing for markets is that investors remain focused on what lies ahead. I expect recurring bouts of volatility. I would be surprised if we didn’t see a few meaningful air pockets. Equity volatility has come down from recent highs but it remains near the top of its historical range.

Just like finding a market bottom is a process, so is rebuilding confidence. I’m counting on the resilience of humanity to see us through this.





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