The House of Commons have been championing a digital interface for individuals to view all pensions in one place for several years now. The pension dashboard, as part of recent labour market and pension reforms, will provide individuals with access to on demand information, and allow individuals to take greater responsibility for investing for retirement. While the advantages are clear, watching recent market moves minute by minute can have an adverse impact on investor behaviour.
So far in 2020, markets have been characterised as a year of superlatives, with erratic moves from extreme pessimism (fear of losing money) to extreme optimism (fear of missing out) to somewhere in between. CNN’s Greed & Fear Index currently stands mid-way between the two, as bulls and bears fight it out for market direction, and fundamentals remain somewhat secondary. Whilst China, the epicentre of the current pandemic, is seeing early signs of economic activity resuming, and several European countries are phasing out of lockdown, investor expectations about future returns may need to be reframed.
Equities trading on sentiment tend to be myopic in nature, as seen in rallies ignoring recent unemployment reports and deteriorating GDP figures, but rather focusing on potential healthcare treatment breakthroughs and hope of an imminent return to normality. The market is ripe for second and third wave shocks, should the market voting system turn into a weighing machine, either from coronavirus related data, or when it is revealed which corporates really have been swimming naked.
Notably whilst equities have rallied, bond yields continue to compress, pointing to a somewhat less favourable environment going forwards. One-year inflation swaps indicate an inflation rate of -1%, while two-year inflation swaps are pricing in an inflation rate just below 0% — the lowest levels since 2008. This compression in yields combined with low growth expectations provides a further challenge to growing pensions, and maintain subsequent drawdowns.
US corporate debt is currently 47% of its total GDP, whilst according to Factset, 17% of the world’s 45,000 companies do not have enough cash to cover interest costs for at least the next 3 years. The next wave could see corporate debt downgrades and fund rebalancing within pension allocations. The financial alchemy undertaken by the Fed allowed 49 companies to issue over $100bn of investment grade bonds in one week – this was the largest week of issuance on record and will assist the further zombification of corporations. In a bid to maximise cost savings, corporate pension schemes have begun to come under the spotlight.
According to the Investment Association, defined contribution schemes for FTSE250 firms have on average 70% of their assets invested in equities. Equities drive the majority of a portfolio’s risk contribution. Allocations to risk assets have crept higher over time as the risk free rate has struggled to rise, and is expected to drive fluctuations in pension pot values as further whipsawing takes place. Whilst it is tempting to make knee jerk reactions, cashing in pension pots, it remains important to stifle these responses. Kicking the tyres on holistic wealth asset allocations to ensure long term objectives are still attainable is key.
FTSE 100 companies have cut or cancelled around £24bn worth of dividend payments given a squeeze on costs, and there has been little indication of when these payouts will be reinstated. Those investors who are reliant on income, may be lured into higher yielding assets, however this can come at a cost in terms of liquidity and default risk. An active, rather than passive, approach can assist here to focus on quality investments, and take into account qualitative elements, such as management actions in the current environment.
Currently the largest 5 stocks (Microsoft, Apple, Amazon, Alphabet and Facebook) in the S&P 500 account for over one fifth of its total market value, representing a higher concentration of stocks than in the tech bubble of 2000. An active approach can again take advantage of this low breadth of the market. A bias towards quality growth stocks in a low growth environment would have been beneficial for pensions, as the S&P 500 Growth index is down 6.5% this year, versus the S&P 500 Value index down 21%. Similarly, within the bond space, the market is ripe for duration management, picking winners and avoiding potential defaults and downgrades.
Integrating diversifying strategies, such as gold can also be beneficial in a negative yielding bond environment, and will hold its worth should the Fed successfully decrease the value of the dollar. Whilst the metal is at its highest level since 2012, it is still undervalued versus global central bank assets, which targets gold at $2,400. Silver also has a tendency to follow gold’s lead.
Market experts continue to debate which alphabet shape we can expect the market recovery to be, nevertheless, we are almost guaranteed to see further choreographed stimulus activities in coming months to reinvigorate effective demand, albeit the risk is a diminishing return to this gargantuan monetary stimulus, which could ultimately lead to a liquidity trap. Investors should keep an eye on long term goals, whilst considering building in insurance to protect against subsequent volatility waves, and avoid emotional reactions.
Christopher Bishun is a CFA and independent consultant
