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DBS sees 'floor' on risk assets; bets on recovery via gold and BBB-rated bonds

Lim Hui Jie
Lim Hui Jie10/9/2020 06:30 AM GMT+08  • 7 min read
DBS sees 'floor' on risk assets; bets on recovery via gold and BBB-rated bonds
Gold, pandemic victims and BBB-rated bonds are things investors should look at as the global economy recovers: DBS
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Gold, pandemic victims and BBB-rated bonds. These are the three areas that DBS chief investment officer Hou Wey Fook advises that investors look at as the world slowly comes out of the Covid-19 pandemic.

On top of a heavy global boost in fiscal spending and near-zero interest rates, economic and normal activities have resumed, says Hou, citing mobility data from Apple and Google. “The world is seeing signs of recovery after a steep recession,” says Hou at the bank’s investment outlook briefing for 4Q2020.

Despite many countries around the world experiencing a second wave of infections as lockdowns were lifted, Hou says that there were lower fatality rates and more successful attempts at “flattening the curve”. As such, he does not believe that the world will undergo another blanket lockdown like what was seen in the first half of the year.

Coupled with “easy” monetary policies and fiscal spending by governments, Hou believes that this “put a floor” to risk assets in 2Q2020, and is now translating into economic recovery. There are several clear factors indicating so. For one, the global manufacturing sector is expanding with new orders at their steepest since mid-2018.

However, full recovery of the labour market will take longer, as traditional business models struggle to undergo restructuring in the new normal, he adds.

Look for ‘pandemic winners’

In its CIO Insights 4Q Report, DBS said investors should either stay invested or pay attention to equities enjoying secular growth, income-generating assets, as well as gold, amid an ultra-low interest rate environment.

Furthermore, based on recent news flow, the race to develop a vaccine for the coronavirus is bearing fruit. Russia, for instance, announced that it has granted regulatory approval for a Covid- 19 vaccine, while a vaccine jointly developed by Moderna and the US National Institute of Health could also be ready by November. In other words, “the plausibility of a Covid-19 vaccine is no longer a matter of if, but when”, the report says.

Based on forecasts, the probability of broad-based treatment by a Covid-19 vaccine approved by the US Food and Drug Administration (by 4Q2020- 1Q2021) stood at only 5% on May 1. The probability has shot up to 61% (as of Sept 16, 2020).

Indeed, should a vaccine be approved in the coming months, it will provide an uplift for risk assets in general. But the positive impact will not be uniform as some industries will benefit more than others.

Hou foresees a stronger recovery for industries like hotels, restaurants, integrated resorts and the beauty industry. Given the highly contagious nature of the coronavirus, industries that require face-to-face human interactions were among the hardest hit during the pandemic. The main casualties include companies operating in the restaurants and casinos space.

But with the prospects of a vaccine by year-end, he believes that this segment could undergo a substantial rebound. In addition, he points out that these pandemic victims are currently trading at about -2 standard deviation (see Chart 1).

As for sectors like the aviation industry, DBS predicts a longer road to recovery, with “more structural pains ahead”. The pandemic has caused air travel demand to collapse across the board, with airline companies grounding the bulk of their fleets.

However, even with a vaccine round the corner, DBS believes that the pandemic has already caused structural damages to air travel, in particular business travel, as online meetings during this period have proven effective as a substitute and might be the norm for more in the future.

Besides, the report points out that should business-related travel resume, the demand for business-class seats (which is the main revenue-generating segment for airlines) will likely be “muted” given the state of the global economy, he says. As such, for sectors like aviation, despite it trading at a very bearish -4 standard deviation, Hou says recovery will be “a little bit longer”.

Remain bonded to bonds for about five years

As for credits, DBS’ report says BBB/BB-rated bonds in Asia and Europe are expected to outperform. In a world where central banks have anchored rates at zero, credit yield spreads will continue to narrow.

Despite the broad-based rebound in the US economy, DBS believes that the US Federal Reserve will err on the side of caution and maintain monetary accommodation amid muted inflation and lingering uncertainties from the pandemic. The bank also maintains a preference for Europe in the developed market high- yield space, given the region’s stimulus agreement and flattening virus curve.

DBS identifies three “revelations of the crisis” that investors have to take into account while investing in credit so as to “optimise [their] credit portfolio positioning”.

Firstly, the report says credit markets must function at all costs. “If the flow of credit is the key to preventing a full-blown recession, then policymakers can and will do whatever it takes to be the liquidity providers of last resort,” it adds. Secondly, the support measures established by policymakers, such as rate cuts, quantitative easing (QE), direct investments in credit markets and Main Street lending, have committed them in a way that discourages the premature reversal of support measures that risks unravelling the recovery.

However, DBS believes that this wide-ranging policy support is not a “free pass” for investors to buy the riskiest debt. Defaults are still expected to rise, and “central banks can backstop liquidity, but they cannot prevent defaults”.

As such, they are “cautious” on bonds in the B/CCC-rating buckets, and recommend the BBB/BB as the risk bucket of choice in this regard, given the comparatively generous credit spreads, lower expected default risk, and importantly, being direct beneficiaries of central bank support. Hence, the report advises that investors should maintain these in their portfolio for an average duration of about five years.

All that glitters really is gold

Most notably, Hou is very optimistic on gold as a “risk diversifier” which will benefit investors in this low-interest environment. According to DBS, gold outperformed all asset classes in 3Q2020, with a return of about 10% during the quarter and about 30% year-to-date. This is attributable to the weaker US dollar, falling US Treasury yields, and uncertainties arising from subsequent waves of Covid-19 cases. “As these tailwinds for gold persist, we continue to see gold being supported at current levels,” the report says.

Furthermore, DBS believes that investment demand for gold has accelerated, as seen from net inflows into gold ETF (exchange-traded fund) holdings, which have been positive every month this year except during the market turmoil in March. This year has also been the strongest year on record since data become available, the report observes.

And it’s not just retail investors that are chasing after gold ETFs, central banks are also expanding their stock of the precious metal. Gold reserves as a percentage of total reserves had stood roughly flattish, but there are indications that this allocation is likely to rise.

In a 2020 survey conducted by Invesco for central banks and sovereign funds, 18% of central banks and 23% of sovereign funds surveyed have indicated intentions to make changes to gold allocations over the next 12 months.

DBS believes the proliferation of gold ETFs and financial instruments should continue to enhance the liquidity of gold and as such, it has a “deserving stake” in an individual’s as well as an institution’s portfolio allocation. DBS’ study has suggested that adding gold to a 50/50 portfolio of equities and bonds improves the risk-adjusted return of the overall portfolio.

Hou is going as far as to describe the growth potential of gold as “infinite”, and say that “the sky’s the limit for the gold”. This is because unlike for industrial metals and like agricultural soft commodities, “even if gold prices surge to three, four, five, or even US$10,000”, central banks and governments won’t intervene.

“This is because it has no impact on the mass population, it doesn’t create inflation. So that’s why we think gold is very important, I would say, holding in your overall portfolio,” says Hou.

The report notes that “given the conditions at the moment being highly supportive of gold, we believe prices could hit the upper end of our forecast range. We are thus upgrading our 12-month gold price forecast to US$2,300.”

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