Quantitative easing: the oft-ignored long-term...
Aykut Efe, Economist at BCEE Asset Management, discusses the potential impacts of quantitative easing on the real economy in the long term.
To stem the spread of the virus, government authorities in many countries around the world have taken drastic measures and called for lockdowns. The pandemic is therefore hitting the global economy hard, as the closure of public spaces such as restaurants, cinemas and bars will inevitably be reflected in much lower consumption figures, and this impact should be visible from the second quarter of 2020. Businesses are in turn reducing their production capacity, or have ground to a complete halt, and have been forced to postpone their investments given the uncertain outlook.
In March, the equity markets plunged at a faster rate as Russia refused to fall in line by rejecting the new OPEC (Organization of the Petroleum Exporting Countries) agreement on the reduction of oil production. Saudi Arabia retaliated against Moscow by opening the floodgates and starting a price war. Against this backdrop, oil prices have tumbled by nearly 50% since 5 March, dragging the major oil stocks down with them.
Volatility therefore set new records on the equity markets, and the stock indices continued to accumulate losses.
Between 1 January and 31 March, the S&P 500 shed 20%, while the Stoxx Europe 600 lost 23% over the same period.
Contrary to popular belief, this widespread sell-off did not benefit assets generally considered defensive. The price of gold, the ultimate safe haven, fell at the end of February and has never risen above USD 1.680/oz since. The usually more stable dollar has depreciated by nearly 2% against the euro since 20 February.
On the bond market, sovereign rates also soared, with Italy taking the lead. Movements of more than 60 basis points were seen in the course of a single day and private debt risk premiums followed in their wake. Only US Treasuries have actually managed to limit the damage since the beginning of the crisis.
It wasn't until the end of the first quarter that the financial markets stabilised somewhat, after central banks and governments around the world developed a raft of measures to support the economy.
In this increasingly complex environment, the lux|funds have been fairly resilient to the recent bout of volatility on the financial markets, thanks to our fundamental economic approach, which can be used to structure portfolios based on the expected development of economic conditions.
Economic forecasts are used to locate the current situation on the business cycle curve. The portfolio structure is then tweaked based on this location and certain forecasts. In practice, the fund manager makes adjustments by manipulating the volume of either cash or money market instruments, or the portfolio's industrial and sector diversification. Changes are made in particular to the ratio between the securities in the portfolio that are sensitive to the economic cycle and those that are less so.
For instance, last year, on the bond side, our mixed view of the global economy, combined with very low risk premiums steered us towards the private debt of defensive companies with sound financial balance sheets. We have therefore been able to soften the impact of the rapid rise in risk premiums due to the pandemic.
In addition, a decorrelation arose at the end of 2019 between the risk premiums on private debt and leading economic indicators, which also drove us towards debt that is eligible for European Central Bank (ECB) purchases. We believed that the buy-and-hold nature of this debt was indicative of both lower volatility and more limited downside risk.
On the US markets, and more specifically on the sovereign debt market, we were positioned for cuts in short-term rates. We had considered this scenario last summer due to excessively contained inflation indicating asymmetrical probabilities for changes in US rates. As a result, our positioning benefited considerably from the expectation, which was subsequently confirmed, that the US Federal Reserve (Fed) would lower rates to counter the economic impact of the coronavirus.
Accordingly, lux|bond USD, which invests only in US dollar-denominated bonds, was able to capitalise on this positioning and ended the first quarter up 6.44%.
lux|bond Green, which invests primarily in bonds that finance green projects, also withstood the headwinds blowing through the financial markets and ended the first quarter of 2020 down 1.24%.
The fund benefited not only from its partial exposure to US dollar-denominated bonds, but also from its underexposure to some of the more cyclical sectors due to its green investment strategy.
In terms of the sector allocation for the equity class, our cautious view of global growth and the high valuations in a number of sectors led us to prefer securities in less cyclical sectors such as Communication Services, Real Estate and Healthcare.
Our defensive sector allocation was a particular boon for the lux|equity Best Sectors fund, which invests only in securities that reflect our sector convictions. Although it was admittedly down 15.99%, its losses were limited compared with the Stoxx Europe 600 and S&P 500 indices.
The lux|equity Low Volatility fund, for its part, served as a bulwark against the heightened volatility on the equity markets. Remember that this fund's sector allocation is based on a quantitative optimisation whose aim is to build a portfolio that is consistent with a low-volatility strategy. With this in mind, the Fund reported 20% volatility, which is well below the level observed on the equity markets, and limited its losses to -16.66%.
Our cautious bond and equity positioning also worked in favour of the funds with a flexible asset allocation, namely the lux|portfolio Global Flexible (0%-100% equities) and lux|portfolio Global Flexible Serenity (0%-50% equities) funds. If these two funds lost only 7.85% and 3.29% respectively, it's also because of their flexible allocation, which is based on our economic forecasts.
For example, the asset allocation for the lux|portfolio Global Flexible fund at the beginning of 2020 was 50% equities and 50% bonds. The worldwide spread of COVID-19 and its impact on the global economy prompted us to take a more defensive stance in February, however, and to change the allocation to 30% equities and 70% bonds.
Following this adjustment, the funds suffered less from the effects of the plummeting equity markets in the first half of March. The many interventions by the public authorities to support the global economy subsequently provided some reassurance and encouraged us to increase our equity allocation slightly, from 30% to 45%, in mid-March. Thanks to this adjustment, the fund was able to capitalise to a greater extent on the rebound in the equity markets at the end of the quarter and, at the same time, to limit its losses.