UBS chief investment officer Mark Haefele is covering all the bases.
He penned a letter to clients on Thursday laying out three market strategies for various economic trajectories. Haefele said the US sits at a key fork in the road, with lingering coronavirus risks, renewed US-China tensions, and high valuations threatening to drag markets back to March lows.
On the other hand, positive news out of coronavirus vaccine trials has lifted investor sentiments in recent weeks. Uncertainty around the pandemic's containment is the key variable to lifting markets from their now-narrowed range, Haefele said.
“For markets to catch a ‘second wind,' investors need greater confidence that a ‘second wave' of virus infections will not lead to renewed lockdowns,” he wrote. “Even if current economic conditions are weak, markets are forward-looking and would likely trade higher if investors gain confidence that a robust recovery will take hold.”
The best near-term strategies depend on how economic reopening takes place. Outlined below are the three scenarios and market plays highlighted by Haefele, from a swift summer upswing to a rush for defensive assets.
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UPSIDE SCENARIO: Buy cyclicals and value
UBS's upside scenario sees the economy coming back online through May and June without the need for a second lockdown. Corners of the market that underperformed through the worst of the pandemic would present serious value and outperform on the upswing, Haefele said.
Both cyclical and value stocks would be best positioned for a better-than-expected recovery. US mid-cap firms haven't shifted to “stay-at-home” trends as quickly as their larger peers, leaving them better prepared to gain on a return to past norms. The relaxing of mobility restrictions will particularly help automakers, beverage, and retail companies, the CIO wrote.
For those eyeing a shift to value stocks, the battered energy sector is the place to be. A rebound in oil demand stands to lift the entire segment, and US energy stocks already reflect crude prices “significantly below our longer-term normalized price expectations,” Haefele said.
Investors should watch out for a weaker dollar should the economy soar back to past levels of growth. While the currency appreciated through the crisis, a slide in liquidity demand will drive the dollar's value lower. The British pound is the best currency for a foreign exchange trade against the dollar in such a scenario, UBS said.
BASE CASE SCENARIO: Favor credit and long-termers
Haefele's baseline scenario projects economic reopening taking place through the summer and economic activity returning to past highs in December.
The more moderate recovery puts credit bets in a healthy spot relative to equities, the CIO wrote. Investment-grade debt, emerging-market bonds, and high-yield credit are all well-positioned for gains thanks to widespread government relief, he added.
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“Policymakers have done enough through their fiscal and monetary response to ensure liquidity issues do not become solvency issues for companies or sovereigns that were viable prior to the crisis,” Haefele said, adding that the Fed's direct purchase of corporate bonds further lifts the asset class.
Even if the recovery isn't as quick as desired, UBS's base case creates long term opportunity in the healthcare, e-commerce, automation, and cybersecurity sectors. Sustainable investing will likely gain new appeal as well, with investors paying greater attention to green and socially responsible firms, according to the bank.
DOWNSIDE SCENARIO: Buy gold, pick stocks selectively
Haefele doesn't offer as clear a picture of what his pessimistic scenario would look like, instead hinting at fresh credit-health shocks and sharp volatility tearing into markets.
In the case of a prolonged recession, one safer bet for investors would be to follow historically successful hedge funds. Active stock picking could help “navigate periods of elevated volatility” better than passive stock-and-bond positioning, the CIO said.
A cocktail of surging US debt, tightened financial conditions, growing geopolitical risks, and dollar devaluation would do wonders for the price of gold, UBS added. The precious metal has already enjoyed a rally to eight-year highs, and even in the bank's base case, it expects gold to gain another 4% to $1,800 per ounce by the end of the year. A more severe downturn would only further boost the popular safe haven.
Lastly, Haefele suggests investors turn to Treasury Inflation-Protected Securities, or TIPS, to offset the chances of soaring inflation. The trillions of dollars spent on economic aid led the market to price in record-low inflation for the near future, so any shift could benefit those holding the protected bonds. TIPS will also gain value if central banks adopt higher inflation targets moving forward, the CIO said.
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