At the end of the third week of lockdown in across much of Europe, senior investment strategist Daniel Morris and Mark Lewis, global head of sustainability research, review the shape of financial markets and reaffirm our belief that this is not the time to sell risky assets.
Mark also discusses the merits of sustainable investing in volatile market environments and the potential implications this crisis will have on the energy sector and broader economy.
What is your view on the current environment in markets? What do you advise investors?
Daniel: A certain stability appears to have returned. In credit markets, the risk premiums on corporate bonds and credit default swaps (CDS) have fallen. The market for new issues of investment-grade bonds has opened up again, in both Europe and the US. Risk premiums on high-yield bonds have also tightened and there have been some inflows to the asset class.
Global equity markets have recently been trading with a better tone. Prices have rebounded and volatility has dropped, even as the trading range remains wide. The rebound is sector-specific as the crisis is likely to have a profound impact on the travel, tourism, entertainment and retail sectors.
While US dollar (USD) liquidity has remained stressed, the cost of issuing commercial paper is prohibitively expensive, even for the better-rated corporates. Once the US Federal Reserve starts buying more short-term paper in the first half of April, the upward pressure on funding costs should ease off.
The significant central bank intervention as well as the recent fiscal packages have provided an underpinning to the global economy and put a break to the downside in markets. In our view, USD liquidity needs to improve further before markets can regain a fuller sense of normality. That said, it is clear to us that central banks will do whatever it takes to stabilise markets. So far, this is working.
No time to sell risky assets
In summary, we remain braced for bad news in the short run. The human cost of this crisis will be hard to bear. There may have to be multiple shutdowns of society and the economy to contain the spread of the virus. However, society will ultimately learn to live with the virus and the economy will recover.
How should we think about sustainable investing in this volatile environment and with these high levels of uncertainty? Is there a risk that governments lose sight of sustainability in their policy responses?
Mark: Sustainable investing is ultimately about building long-term resilience into portfolios. This crisis shows how important such resilience is for investors. The extreme market volatility of recent weeks has revealed fragility across health systems, economies and asset markets. Globalisation, technological change and competition helped to foster a global economy that appeared efficient, but it is vulnerable to large disruptive shocks.
So the first lesson is that our world is more fragile than we think. We need to think more about resilience. That applies to policymakers, to CEOs of large corporations and to us in finance. There is an enhanced role for sustainable investing to contribute to this resilience in long-term investments.
As regards the responses of governments to this crisis, I am more optimistic about sustainability’s place on the policy agenda than I was in the wake of the 2007-2008 financial crisis. Then it was deprioritised.
This time is different because the crisis has laid bare a degree of fragility in even the most advanced economies and the best health systems. It is really concentrating minds and we are already seeing signs of more imaginative policy responses being envisaged.
Our economies will change and governments can advance sustainability by, for example, rebooting green infrastructure. I would anticipate policy responses would boost the decarbonisation of the global economy.
How are you and your colleagues in the Sustainability Centre coping with this exceptional situation?
Mark: Our team of 25 investment professionals is spread across the globe, in Asia, the US and Europe. We are all working remotely and the last few weeks have been a crammer in collective remote working. Conference calls have replaced meetings. We use video conferencing several times a day.
The experience has focused our minds on how much more efficiently we can work in the future. It of course raises questions about travelling and conventional office working. I think this experience will profoundly change attitudes and behaviour towards travel in particular with positive outcomes for sustainability.
You have done a lot of research on the energy sector. What is your analysis of the implications of the collapse in the price of oil?
Mark: We have seen the biggest and most dramatic drop in oil prices since the first Gulf war in the early 1990s. In early March came the news of the collapse in OPEC’s agreement on pricing. The COVID-19 pandemic has intensified downward pressure on oil prices through demand destruction as populations are immobilised. So we have increased production, as oil producers wage a price war, meeting a massive contraction in demand. It is an extraordinary situation. When demand for oil troughs, it may mean a fall in demand of 45 million barrels/day.
Such a slump would be unprecedented. It inevitably raises questions about ‘peak oil’, that is the idea that sometime in the next decade, demand for oil will peak before going into long-term decline. The question may arise as to whether the peak in demand for oil occurred in 2019. Whatever the answer, the fall in oil prices is a major challenge for the oil majors. It will require them to make their business model more resilient. That would mean a greater focus on renewable energy sources.
So that brings us back to the focus on resilience both in sitting tight in the coming weeks and building portfolios that will bring sustainable returns over the long term.
Any views expressed here are those of the speakers as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.