Four themes to set your portfolio for economic recovery

We are only months into the start of a new economic cycle, and this is a perfect opportunity for investors to get positioned for years of economic growth ahead. The cycle is already off to an unusual start, kicking off with a pandemic and unprecedented government and central bank stimulus.

Not surprisingly, there is good and bad news for investors looking to reposition their portfolio. The good news is that there are clear thematics that long-term investors can take advantage of over the next decade.

The investment themes guiding the next cycle

Some of these thematics have been driven by health risks stemming from COVID-19, including those that resulted from a shift in consumer spending and businesses re-orientating operations.

Niche technology groupings like eCommerce, digital payments and collaboration/productivity tech are expected to benefit from the post-COVID-19 behavioural shift. But let’s also not forget the value end of the market that is set to benefit from the growth recovery and especially from a vaccine. We’re keeping an open mind for COVID-19 therapies and vaccines that are plausible, plentiful and potent that would see a normalisation of consumer services and underpin cyclical sectors.

The not-so-good news is volatility is not going to vanish in the short term, and there is still a lot of stimulus and accommodative monetary settings required to recover from COVID-19. Policy co-ordination will be paramount to ensure sustainable economic gains do not vanish once temporary programmes and initiatives fade.

The chart below shows the monetary and fiscal stimulus for the last 20 years (with cash rate falls represented as an upwards move for consistency with the fiscal policy response).

The Reserve Bank announcements this week have taken measures even further, including reducing the cash rate to 0.1%, setting the 3-year government bond target to 0.1% and expanding asset purchases (quantitative easing) to $100 billion of Commonwealth and State bonds. 
 

Australia’s Monetary and Fiscal Impulse

Source: Citi Research

Looking forward, investors can consider the following thematics as crucial to their portfolio construction.
 

1. Borrowers cash in on debt

Governments will take advantage of a low yield environment to finance long term infrastructure spending, which is expected to be a large driver of growth and a primary tool for reducing elevated unemployment rates due to the pandemic.

Businesses will also be opportunistic to borrow at 'rock bottom' yields to fortify their balance sheets and it is expected that balance sheet management will be a key part of strategy as the economy re-energises, and as we’ve seen the correlation between balance sheet weakness versus balance sheet strength is a key measure between performance and underperformance.

For investors, fixed income opportunities will arise in both the primary and secondary 'over-the-counter' bond markets as new issuances are created to finance corporate and government objectives. 
 

2. Identifying sectors with long-term growth potential

The vaccine is key to long-term stability as economic recovery kicks in. This means that investors will be more guarded and cautious, particularly until the vaccine becomes a reality.

Given we already have high valuations in some sectors, like tech, we have a mid-2021 ASX200 target of 6200, and it will not just be an upward trajectory. We expect sector rotation from COVID-19 beneficiaries such as the tech sector/health sector to the cyclical sectors that includes resources and industrials especially if there is firmer footing in a broad economic recovery.

But we can also see an expectation that government, central banks and regulators will maintain discipline in nudging the recovery forward.
 

3. Consider elevated risk the new normal

Volatility is here to stay, and investors should prepare their portfolios accordingly. Risk remains at elevated levels, with some of the key risk-factors including:

• The US presidential election fallout and post-election destabilisation
• Racial inequality unrest
• Global trade restrictions, particularly as a result of any escalation of US-China tensions
• Second waves of COVID-19 across continents or key countries as the northern winter settles in
• Any failure or significant setback of promising vaccines.

Our recommendation through this period of heightened volatility is not to play the short game and avoid trying to time the market.

Investors can consider structured investments, which can be tailored to produce income in flat, falling or rising markets. We anticipate a flat equity market, with crowded investment positions shifting away from out-of-favour sectors, such as industrials, materials and financials, until growth becomes sustainable and delivers heightened production and economic activity and rising yields.
 

4. Seek balance and remain allocated through the investment cycle

Citi prefers a balanced portfolio that allows diversification to play its role as a modifier of risk, and includes income assets, like corporate and selective high yield bonds, that provide cash-flow stability. This is especially true with rates and yields sitting at the bottom of the curve, and we expect it to remain this way for several years.

Equities remain an important part of asset allocation and will form an increasing percentage of a portfolio as the recovery gains traction. However, it’s likely many investors are sitting on equity portfolios built up in the previous economic cycle, and require adjustment to suit the next set of anticipated thematic trends.

In the current market we remind investors to remain open-minded to adding cyclical and value-driven stocks to their portfolio, particularly if they are under-allocated to equities after selling down their portfolios in response to the chaos caused by the virus.

We reiterate our long-maintained stance to remain allocated through the investment cycle, as sitting on the sidelines means you miss out on the best days in the market, which may mean forgoing initial recovery periods that can often include healthy indices increases.
 

First published on the Firstlinks Newsletter. A free subscription for nabtrade clients is available here.