The Macro View by Lionomics, May 2020

We work with Wilshire, one of the nation’s largest investment research consultants, to bring you investment advice and market insights. Each quarter in The Macro View, we summarize Wilshire’s viewpoint on the macroeconomic landscape and the asset classes that may make up the core components of your investment portfolio.

What’s macroeconomics, you ask? It’s the study of large-scale or general economic factors, such as interest rates and national productivity. Let’s dive into the latest quarter.

COVID-19 Brings Widespread Uncertainty

Following a strong start for risk assets in 2020, the market environment changed significantly in mid-February as it became clear that the spread of COVID-19 was beginning to evolve into a global pandemic, thereby increasing the risk to the global economy and financial markets. 

Over the course of just one month (2/19/20 – 3/23/20), global risk assets (stock and bond investments) experienced a spike in volatility that coincided with “deleveraging” across financial markets. This spike was made worse by an oil dispute between Saudi Arabia and Russia, which sent energy markets into a tailspin, further contributing to a deleveraging cycle. (Deleveraging refers to a continuing fall in the prices of financial assets after an initial market downturn. It is part of the process that can lead the economy to recession.)

As a result of this spike in volatility: 

  • Global equities tumbled nearly 34% from peak to trough (in late March)
  • The daily volatility of U.S. equities rose to an annualized rate of more than 80% (normal long-term volatility is only about 15%)
  • Corporate credit bonds and mortgage-backed securities traded at significant discounts
  • Municipal bond yields traded at very unusual premium yields to U.S. Treasuries. 

And this all happened in just one month! For perspective, this kind of fallout took 15 months to play out during the global financial crisis from 2007 – 2009.

Asset class perspectives — MoneyLion portfolios

Taking the impact of the global pandemic into account, Wilshire has adjusted its portfolio positioning to help protect against continued volatility worldwide. Below we’ve summarized Wilshire’s Q2 2020 viewpoint on the core components of MoneyLion members’ investment portfolios. 

Fixed income vs. equity

Given the economic uncertainty and the lack of clarity into both GDP and corporate earnings (two indicators of economic health), Wilshire believes that it is best to keep allocations consistent and that it would not be prudent to add any more active risk to try to take advantage of current valuations.

Global ex-US vs. US equities

The U.S. has already provided substantially more fiscal and monetary stimulus relative to foreign developed nations, and has demonstrated effective collaboration across political party lines. Europe and Japan are not as well positioned. As a result, Wilshire is removing their overweight view to international in favor of neutral posture in U.S. vs. Non-U.S. equities.

Emerging markets vs. developed equities 

The risk that COVID-19 presents to emerging markets, particularly with respect to the more limited ability of many emerging economies to deal with the humanitarian crisis of this pandemic, increases the uncertainty in the outlook for emerging vs. developed equities. As a result, Wilshire is moving to a neutral view in emerging markets.

Gloomy Outlook Doesn’t Surprise Investors 

The global economic outlook is very gloomy and highly uncertain. Forecasts for U.S. GDP growth in the second quarter have been highly variable, with the most bearish estimates as low as -34%. The deterioration in the Purchasing Manager Indexes (PMIs) and Leading Economic Indicators is far worse and abrupt than what occurred during the global financial crisis, respectively. 

These declines, along with declines in retail sales and a spike in jobless claims, haven’t exactly surprised pandemic-weary investors, and the weak economic data has been met with very mild reactions in risk assets (largely, because it was expected given current data and news coverage) as most markets corrected in advance of the initial decline of economic indicators.

Government Is Acting Swiftly to Help Economy 

At this point, investors are likely to be focused on the implementation of government stimulus, the evolution of the pandemic, the path to restarting the economy, and the underlying liquidity and/or stress in financial markets (which we discuss in the last portion of this update). 

The U.S. has acted proactively and forcefully to offset the economic impact with coordinated monetary and fiscal stimulus that amounts to more than 30% of GDP and includes expanded powers for the Fed to make outright purchases of a variety of securities, such as ETFs and corporate bonds. (The Fed has traditionally purchased only government bonds when attempting to support markets and the economy). 

While there are some initial signs of COVID-19 peaking, and there have been promising advancements in the development of therapeutics and treatments for this virus, the evolution is hard to forecast — even for the most seasoned medical experts.

Signs that Recovery Will Be Gradual: Looking to China

We are beginning to hear some details about the path to reopening the U.S. and other developed economies; however, the timing and success of such efforts is unclear. Fortunately, we can look to China as an indication of what this path may look like.

Despite a significant jump in the China PMI surveys, which indicate a V-Shaped outlook (a drop followed by a quick increase, like the letter V) for the economy (Exhibit A), the actual hard data signals a gradual recovery (Exhibit B). And some market analysts have suggested that the path of economic recovery could look more like a U, W, or Nike Swoosh. 

These measures show that the path to recovery is likely to be gradual in nature and will certainly be a function of the duration of the economic shutdown.

Exhibit A: CHINA PMI SURVEYS SIGNAL EXPECTATIONS OF A V-SHAPED RECOVER

Source: Bloomberg

Exhibit B: CHINA HARD DATA SIGNALS GRADUAL SIGNS OF RECOVERY IN RETAIL SALES, INDUSTRIAL OUTPUT, AND FIXED INVESTMENT

Investor sentiment — Sad Summer in Store?

The gradual decline in the VIX Index from extreme levels indicates improving sentiment as the market is implying a decline in volatility in the months ahead (Exhibit C). Nevertheless, the August VIX futures contract sits at 34, which implies that investors expect continued elevated volatility through the summer months, particularly relative to history. 

It’s reasonable to expect that, while the worst market performance may be behind us, we should continue to experience heightened volatility, as markets do not appear to be pricing in (accounting for) all of the economic risks at this time. 

EXHIBIT C: VIX FUTURES SHOW EXPECTATIONS OF A DECLINE IN VOLATILITY THROUGH AUGUST, WHILE STILL ELEVATED

Outlook: What to watch in the months ahead

While risk assets found support later in March on the heels of swift and substantial government stimulus and intervention, the foreseeable future is clouded with a tremendous amount of uncertainty, which increases the probability that volatility will remain elevated for months ahead. 

As always, it is good investing behavior to keep a diversified portfolio, which MoneyLion members can maintain by choosing one of seven options based on their risk preferences. Additionally, investing on a recurring basis using Auto Invest allows MoneyLion members to stay consistent through macroeconomic developments without attempting to time the market 

Disclosures

Wilshire Funds Management (“WFM”) is a business unit of Wilshire Associates Incorporated (“Wilshire®”). 

This material contains confidential and proprietary information of WFM. It may not be disclosed, reproduced or redistributed, in whole or in part, to any other person or entity without prior written permission from Wilshire.

This material is intended for informational purposes only and should not be construed as legal, accounting, tax, investment, or other professional advice. Past performance is not indicative of future results. This material may include estimates, projections and other “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented. Forward-looking statements speak only as of the date on which they are made and are subject to addition, change or deletion without notice; we undertake no obligation to update or revise any forward-looking statements. 

This material represents the current opinion of Wilshire based on sources believed to be reliable. Wilshire assumes no duty to update any such opinions. Wilshire gives no representations or warranties as to the accuracy of such information, and accepts no responsibility or liability (including for indirect, consequential or incidental damages) for any error, omission or inaccuracy in such information and for results obtained from its use. Information and opinions are as of the date indicated, and are subject to change without notice.

Wilshire is a registered service mark of Wilshire Associates Incorporated, Santa Monica, California. All other trade names, trademarks, and/or service marks are the property of their respective holders. Copyright © 2019 Wilshire Associates Incorporated. All rights reserved. 

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