Mike explains why, after the recent market turmoil, it may make sense to rebalance your portfolio outside the usual calendar.
Fears of the outbreak of the corona virus and its economic consequences have triggered drastic market movements in the past few weeks. As a result, the composition of many portfolios has moved away from what they have assumed across a broad level of asset classes. Sharp stock sales and declining government bond yields have mechanically underweighted and overweighted many portfolios compared to their general asset allocation benchmarks. We prefer realigning towards benchmark weights, but recognize that the timing and implementation will vary depending on the investor.
Many investors balance their portfolios on a calendar basis using strategic benchmarks. However, extreme market movements have likely caused their portfolios to drift dramatically from the benchmarks. We illustrate with a hypothetical portfolio of 60% stocks from industrialized countries and 40% global bonds. Last month, the weight of stocks in the portfolio would have quickly shrunk to just over 50% due to a strong stock sell. This one-month drift was sharper than during the 2008 crisis. See the table above. We continue to see benchmark weights as appropriate. This implies the need to rebalance portfolios – to effectively buy stocks and sell bonds. However, we believe that it is too early to overweight stocks. Given that we are waiting for signs that coronavirus infections are at their peak and that decisive political measures stabilize the economy and the markets, it may be advisable to lean against market movements by realigning them. The right time for this varies depending on the investor and should take into account considerations such as transaction costs and market liquidity.
The outbreak of the corona virus is a major external shock to the macro outlook, similar to a major natural disaster. Public health measures designed to stop the virus from spreading are expected to bring economic activity to a standstill and cause economic growth to contract sharply in the second quarter. However, we expect activity to ultimately return with limited permanent damage as long as the authorities deliver an overwhelming fiscal and monetary response to the bridge between businesses and households through the shock.
The policy response required includes drastic public health measures to contain the outbreak – and a critical, preventive and coordinated policy response to stabilize economic conditions and financial markets. That’s all begin to take shape. Central banks have cut interest rates and taken measures to ensure that markets continue to function. The key here is to alleviate malfunctions in market prices and tighten financial conditions. What is needed is an overwhelming and coordinated policy – both monetary and fiscal – that prevents any cash flow crisis, especially for small businesses and households, that could lead to financial burdens and could lead the economy to a crisis, such as we describe in detail Time for a direct policy. The UK, Canada and Australia have served as policy coordination models, as we advocated in Dealing with the next downturn. We expect a third, much larger fiscal package to hit the market soon – probably $ 1 trillion or 5% of GDP – in the U.S., although there may be twists in the path through Congress.
We maintain the reference weight for stocks, credit, government bonds and cash, but have updated our detailed views on asset allocation for the next six to 12 months. We emphasize regions with the greatest political leeway – like the United States and China for both equities and loans – and prefer quality risks. We are upgrading US stocks because of their quality distortion and expected support from fiscal incentives. We downgrade Japanese equities due to limited monetary and fiscal leeway to offset the impact of the outbreak. In the case of fixed-income securities, we reduce the inflation-protected securities (TIPS) to neutral after an enormous drop in interest rates, although we still see a value in the long term. We are upgrading peripheral euro area government bonds to neutral following the recent spread widening and expect the European Central Bank’s actions to keep yields low in southern countries. Significant value for risk assets has been created for long-term investors.
Mike Pyle, CFA, is Global Chief Investment Strategist at BlackRock and heads the Investment Strategy role within BlackRock Investment Institute. He regularly writes articles The blog.
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