Investing Through The Recovery | Barita Insights | June 21, 2021

The ‘business cycle’ is what economists use to define the different phases that an economy transitions through; similar to the four seasons. They identify these phases as Peaks, followed by Recessions, then Troughs which are followed by a Recovery then back to the Peak. This cycle has been repeated and recorded from the start of economic theory, and they remain true today. However, for every transition to a new cycle (which is defined as going through all four phases) there is a ‘Structural Shift’. A structural shift encompasses multiple factors such as consumer behavioural changes, monetary and fiscal policy changes, and risk-return dynamics in capital markets to name a few. The ‘break’ in the structure of the economy is always important to identify as the ensuing decisions made at the macro and micro level will materially differ and will have implications on factors such as fiscal spending for sovereigns, asset allocations for investors, and goods and services produced by businesses.

Where Are We Now?

Before COVID-19, the last structural break globally was the Great Financial Crisis in 2008-2009. This event was well documented and continues to be a teachable moment for stakeholders in the economy. The ensuing environment following this period was characterized by low-interest rates and increased regulation/oversight of the financial system. This had further implications on areas such as real estate, the labour market, and even global trade. Following the recession, the globe witnessed a decade-long expansion. However, COVID-19 disrupted this expansion; thereby making 2019 the last Peak. COVID-19 created a Recession due to a period dubbed The Great Lockdown which resulted in the simultaneous closure of economic activity globally at a magnitude not seen since the World War Era (another business cycle). However, since this was a deliberate effort to slow the global pandemic, policymakers took deliberate measures to reignite the economy. This was in the form of unprecedented and extraordinary fiscal and monetary policies which resulted in multiple fiscal stimuli to households and businesses directly coupled with the anchoring of lending rates by central banks to near-zero (theoretically allowing borrowing to be free). COVID-19 also fast-tracked the fourth industrial revolution which is a digital one, essentially everything has to do with the digitization of production and manufacturing including Internet of Things (IoT), Cloud Computing, Software as a Service (Saas), Cybersecurity, Big Data, Artificial Intelligence and Mobile Technologies to name a few. On the consumer side, this has caused consumers to rely more on digital services provided by businesses such as Uber (transportation and food) and Amazon. How employees operate remotely through services such as Zoom and Microsoft Teams are just a few ways consumer behaviour has changed.

What Does This Mean To Investors?

These efforts on the part of policymakers, and the adaptation by businesses and consumers have created a strong Recovery from the Trough of 2020. This Recovery is supported by inflation levels rising globally (although deemed temporary due to the ‘base effect’ and supply dislocation) and GDP outturns higher than that of the 2020 slump. As capital markets traditionally act as leading (forward) indicators of the economy, knowing how to position one’s portfolio is very important. This becomes paramount when considering the macroeconomic backdrop in which this Recovery is unfolding.

We are operating in an environment that is encompassed by uncertainty with regards to the medium and long-term implications of the policy decision. Some market participants are concerned about premature ‘tapering’ of the central banks which have acted as the backbone of the capital markets over the last 18 months. Some participants are concerned about a potential ‘asset bubble’ that is growing, like that of the DotCom Bubble in the late 1990s with technology stocks trading at relatively high valuations to the market (sounds familiar?). Regardless of the stance chosen, what we at Barita have determined as a surety is that discipline is required to generate alpha during this period of uncertainty.

Equities: Markets traditionally trade with ebbs and flows. As such, portfolio positioning, hedging and timing remain paramount. This can be manifested through adequate exposure to defensive stocks such as Technology and Healthcare, cyclical stocks such as Financials, and Industrials. The infrastructure plan for the global economy over the medium term gives support to Materials and Utilities. 

Fixed Income: Any lift off in rates will impact fixed income securities, as such, remaining to the short-end and the ‘belly’ of the curve offers the highest quality of protection. Investment in securities with modified durations below 7 offers the highest quality of insulation from countercyclical measures while allowing for yield generation. Investors however should be mindful of the quality of the credit.

Alternative investments: This asset class spans multiple forms, but common features offered are yield enhancement and portfolio hedging. Given the current market dynamics, the inclusion of Alternatives within a portfolio should allow for the outperformance of the traditional 60/40 portfolio structure.