InvestmentsApr 7 2020

How to asset allocate in the current crisis

  • Describe some of the challenges with asset allocating in the current environment
  • Identify how different asset classes are performing
  • Describe why some traditional diversification assets do not work so well
  • Describe some of the challenges with asset allocating in the current environment
  • Identify how different asset classes are performing
  • Describe why some traditional diversification assets do not work so well
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How to asset allocate in the current crisis

The cheaper “value” stocks that survive the next few years, therefore, already have a fair amount of bad news priced in.

That does not mean they could not fall further.

However, it is the stocks which are still expensive which might still have the furthest to fall if the outlook gets worse.

Source: Refinitiv Datastream, JPMorgan Asset Management

Some investors have potentially been lulled into a false sense of security by certain stocks that have delivered very strong growth over the last few years.

While some stocks have delivered fast growth against a backdrop of slow economic growth, that is not the same thing as being able to deliver growth when the economy is contracting.

Many of the best performing stocks over the last few years have been in fast-growing but highly cyclical industries.

Just because some industries such as advertising, retail and corporate IT, have shifted partly online or to the cloud does not mean that they are immune from potential declines in earnings during an economic downturn.

Watch out for fallen angels

Within credit, a focus on companies with strong balance sheets and defensive cash flows could also help limit the downside relative to weaker and more cyclical companies.

The corporate sector entered this downturn with historically elevated levels of debt relative to GDP.

High yield credit spreads have widened out materially already.

The sharp fall in the oil price will put significant pressure on high yield energy companies and spreads for energy credits have already dramatically widened, pricing in the fact that some will default unless oil prices recover quickly.

Non-energy high yield spreads have also widened but by less than for energy companies.

Non-energy high yield spreads could therefore have further to widen if the economic outlook for the wider economy continues to deteriorate.

Source: Refinitiv Datastream, JPMorgan Asset Management

Within investment grade credit, leverage has risen over the last decade and the share of indices which is made up of BBB rated credits is around 50 per cent in most developed markets.

The hit to revenues and profits caused by the downturn in the economy could lead to several BBB rated companies being downgraded to junk status.

Spreads for bonds which are currently investment grade could therefore have further to widen.

In regions where central banks are purchasing investment grade corporate credit, the gap between the performance of those bonds which remain investment grade rated and those which get downgraded could be particularly stark, emphasizing the benefit of an up in quality approach within credit.

Poor liquidity in credit markets could also exacerbate spread widening for some credits beyond what would normally be justified by their default risk.

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