When considering asset allocation today, tactics depend on timing. Investors must consider if they are positioning themselves for the short term — the trough of the recession and any modest pre-vaccine recovery — or the longer term — the post-vaccine resurgence in global economic activity and the growth thereafter. Doing so will determine the amount of risk justifiable in a portfolio.
So long as COVID-19 remains a major public health concern (as in, before a vaccine is widely available), investors should position themselves defensively.
Central bank policy easing has pushed bond yields to near record lows, and stress in credit markets created by cash flow concerns have added further complications to the hunt for yield. Given this, investors should be generally underweight bonds and use them primarily as ballast: quality is key, suggesting sovereigns, investment-grade corporates, agency MBS and high-quality municipal debt; and given the risk of an equity market correction or medical disappointment, which could push yields lower, duration can hedge returns. Moreover, the favourable U.S. yield environment relative to the rest of the developed world suggests a domestic bias.
An underweight to bonds necessitates an overweight to stocks, which may seem antithetical to the idea of defensive positioning. However, as within fixed income, a tilt toward quality eases some of these concerns. A focus on larger-cap stocks is warranted given their better profitability and lower debt loads, while certain sectors — namely technology, consumer staples and health care — provide both a quality tilt and take advantage of current social distancing-related trends. In addition, the global nature of this pandemic and the reemergence of trade tensions suggest that another global flight to quality — as witnessed in the first quarter — may come later this year; a domestic tilt would protect against this. For investors looking beyond the immediate crisis, however, portfolios do not need to be as defensive. Global yields are likely to rise alongside stimulus-related inflation, improving the income prospects of bonds but making duration less appealing. In addition, while some of the near-term equity market winners may continue their winning streak — namely technology and health care — investors can expand their allocations to take advantage of more cyclical trends as well, like the return of consumer discretionary names and financials.
The ability to take risk also allows investors to move down the market cap spectrum, as small caps typically outperform in recoveries, and focus more on international assets, with high growth opportunities in the emerging world, especially Asia, and valuation and income-related tailwinds in certain developed markets like Europe and Japan.