The COVID-19 coronavirus outbreak and its effect on the global economy have pushed market volatility to levels not seen since the global financial crisis. At its close on March 9, 2020—the 11th anniversary, as it turns out, of the US bull market for stocks—the S&P 500 Index was down 18.9% from a record high reached nearly three weeks earlier. The drawdown in oil prices and the decline in bond yields have been even more dramatic.
Rapid market moves like these have justifiably unnerved investors. Still, we think the selloff has created attractive buying opportunities for active managers. Valuations in many return-seeking sectors, including equities and credit, have reset at more reasonable levels, particularly in light of our economic forecasts. While the Goldman Sachs Global Investment Research team expects the world growth rate to slow to 2% this year and recessions in China and parts of Europe, they are not expecting a US recession.
Could market conditions get worse before they get better? Sure. And monetary easing may not be as effective this time as it has been in the past. But we think fiscal support is likely, while lower energy prices should help consumers. That leaves us inclined to tilt toward return-seeking assets, favoring equities over credit and credit over low-yielding government bonds.
On March 10, GSAM’s senior investment professionals discussed the potential investment implications of the coronavirus’ spread. Here are the key takeaways:
Nearly 80% of S&P 500 companies now have dividend yields that exceed the 10-year Treasury yield. And nearly three quarters of these companies have free cash flow yields that exceed their dividend yields, suggesting that those dividends may be secure. In Europe, too, there are companies that currently have dividend yields of more than 3%. And keep in mind that some price declines are being driven in part by reduced liquidity. This suggests there are opportunities to target the shares of companies with attractive secular growth stories where prices and valuations are dislocated. But strong balance sheets are especially important: companies must be able to fund themselves if global capital market dislocation persists.
Even as markets correct sharply, growth stocks are still outperforming their value counterparts, with spreads in the US and Europe at levels not seen in decades. But we see value in value equities and in small-cap value stocks in particular. Yes, energy and financials are heavily represented in small-cap indices, and some will likely struggle with oil and interest rates extremely low. But we see potential opportunity for active managers to generate alpha elsewhere in the small-cap universe.
With 10-year Treasury yields well below 1%, it’s clear that investors will have to look to other assets to generate the income they need to pay for college or save for retirement. With risk assets cheapening up, we see opportunities to do that in the credit market. Downgrade risk tied to the coronavirus and lower oil prices has increased, and some energy-specific and tourism-related companies are vulnerable. But yields are significantly higher, and with a selective approach that focuses on companies with strong cash flows, investors can potentially increase their income-generating potential. And because we expect the Federal Reserve to cut rates and expand its balance sheet, we wouldn’t be surprised to see it restart agency mortgage-backed bond purchases. That will lower yields and reduce supply, enhancing the appeal of investment-grade corporate credit. Those seeking equity-like return potential with less volatility may want to consider high-yield corporate bonds, where average yields are now close to 8%.
Despite recent market turbulence, equity factor returns have been remarkably consistent, with quality factor strategies holding up particularly well. This makes sense, as we expect well-run, cash-rich companies to weather the storm best. Investors are wisely paying close attention to how companies are growing. We’re focused on seeking stable, financially-conservative firms that have been prudent with their cash.
We believe investors should ensure that their managers are focused on how exposed they are to things that are moving markets. That means scrubbing portfolios to gauge sensitivity to sectors most vulnerable to the coronavirus’ spread—airlines, gaming, industrials, to name a few—and to companies most impacted by the global supply/demand disruption. Asset managers should be actively managing where they are taking risk in their portfolios.