Investing During Times of Uncertainty and Low Interest Rate

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Prepared By : Mak Yee Than, Chong Ming Wah

Investing, by definition, is the allocation of capital (money) in assets, financial and otherwise, in the present with the expectation of yielding monetary gains in the future. In trying to predict the future outcome, which is practically an unknown, investors weigh the present risks that they may be seeing or anticipating in order to maximize their investment returns and limiting potential losses. It is the uncertainty of various types that becomes a factor in the investors’ efforts in deciding where to allocate their capital or at all. While generally most investors are averse to uncertainty, there are other market participants who use uncertainty to their advantage.

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Covid-19 Economic Crisis

First reported in the central Chinese city of Wuhan, the novel coronavirus, or officially referred to as Covid-19, has spread to all over the world, infecting millions and killing hundreds of thousands.

In order to contain the pandemic, many governments implemented cordon sanitaire measures, or more commonly known as lockdowns or restriction of movement, to curb the spread of the virus. As a result, businesses were shut and consumption was curtailed, grinding economic activity to near-complete halt and resulting in the loss of millions of jobs. This led to what many economists believe to be the worst recession since the Great Depression of the 1930s.

In late June, the International Monetary Fund (IMF) in its World Economic Outlook report predicted that the global economy will shrink by nearly 5 percent, the steepest negative growth since World War Two. The following are the projected growth rates made by the IMF for major economies,

  • United States, down 8%
  • Eurozone, down 10.7%
  • India, down 4.5%
  • Russia, down 6.6%
  • Brazil, down 9.1%
  • Mexico, down 10.5%

Nonetheless, the organization expects China, the world’s second largest economy, to still grow by 1 percent in 2020, and a 5.4 percent global rebound in 2021, on the assumption that the pandemic will not see a second wave and reinstated lockdowns.

Uncertainties Persist

More than a third of the world’s population had been placed under lockdown over the course of the pandemic, leading to significant changes to energy consumption, retail spending, supply chain management, tourism and hospitality, etc. Economists believe it will take years for some industries to recover from the crisis, if at all.

While many countries have reopened their economies, a recent resurgence of infections such as in the United States, Australia and others has led to the return of some lockdown measures. Furthermore, although many countries are believed to have contained the virus, medical experts have warned about possible second or third waves of infections, adding to the level of uncertainty.

Even if the number of Covid-19 cases come down to manageable levels, such as in Malaysia, Thailand and New Zealand, social distancing requirements and public awareness of lingering coronavirus or other types of diseases may be an obstacle to recovery toward the pre-pandemic life. For example, consumer discretionary spending on entertainment or dining may be greatly reduced should seating limit be enforced, while the effects of working-from-home on productivity remain to be seen.

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What Should An Investor Keep In Mind?

Although risk is a fundamental part of investing, it may be especially undesirable during times of uncertainty for some investors but at the same time presents great opportunities for other investors.

Cash Is No Longer King

The low interest rates environment has thrown into question the conventional wisdom of maintaining a certain level of cash holdings in any portfolio at any given time. To stimulate growth and help keep companies afloat, central banks around the world have brought borrowing costs to near-zero levels, making interest-bearing cash less desirable than ever. This makes investing in non-cash investments all the more attractive, especially when many risky assets can be fetched at low valuations. Furthermore, low interest rates help companies improve their financial position, and encourage consumers to spend more.

Investors have several options to take advantage of the low interest rates environment. Real estate, for example, is a rate-sensitive sector. Demand for properties rises if cost of financing a mortgage falls as a result of low interest rates. Another example is retail, which tends to thrive when rates are low as consumers have more disposable income to spend. Meanwhile, the financial sector, which primarily consists of banks, is deemed less desirable when profits from loans are hurt by low interest rates. Therefore, a prudent investor would understand that, considering the risk-reward ratio, investing in riskier assets could potentially be more favorable than holding cash in times of easy monetary policy.

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It’s Reflation Instead of Inflation Or Deflation

Reflation is the stimulation of economic output and spending with the objective of curbing deflation, which typically comes after a prolonged period of economic downturn. There are two categories of reflation policies.

The first is monetary, which is implemented by central banks to adjust the money supply and influence cost of borrowing. Central banks may boost the amount of currency in circulation by buying liquid instruments from markets, and lower different type interest rates to discourage savings and encourage spending or investments.

The other is fiscal, which refers to measures taken by governments with the same objective of boosting economic activity and relieving deflationary pressure. A reduction in tax rates allows businesses and individuals to have more money at their disposal. Similarly, governments may embark on large and ambitious projects that create jobs and raising income levels.

It is presently unclear if there will be deflation or how deep it will be if there is one. It is, however, clear that reflation has become a worldwide norm. Therefore, it is recommended that investors seek appropriate levels of exposure to assets that stand to benefit from reflation, such as the consumer staples, precious metals and commodities or raw material sectors.

Image Source:https://www.kpbs.org/news/2019/jul/31/fed-cuts-interest-rates-for-1st-time-since-2008/

Wider Scope of Diversification

Introduced by Harry Markowitz, a Nobel Prize-winning economist in his Modern Portfolio Theory thesis, diversification is one of the most important and influential theory that is widely adhered to by modern day investors to minimize portfolio risk and enhance risk-adjusted return.

With the ever uncertain economic environment created by the Covid-19 pandemic, the conventional allocation into cash holdings, fixed income and stock may not be sufficient to mitigate risk at an optimum level. Additional investment instruments such as precious metals, real estate, private equity, hedge fund, commodities and derivatives related products should be included in portfolios not just to manage risk but also to establish exposure to more opportunities for other sources of income and potentially higher return.

Beside diversification in asset classes, a balanced and healthy portfolio can also consist of exposure to alternatives investment products in different markets, countries and currencies. Especially true in an inter-connected world of the 21st century, with the help of technology and ease in flow of capital, investing has become an endeavor that transcends borders, which is now readily available to even retail investors.

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Invest In Gold To Protect Downside

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In the eyes of many investors, gold has several roles to play. First, the precious metal is regarded to be a safe haven asset in times of uncertainty due to its perceived lower volatility than that of risky assets such as equities. Furthermore, being a non-interest bearing asset class, the appeal of gold increases when the interest paid on cash is lowered. Another unique trait of gold is its inverse relationship with the US dollar. Most importantly, gold is a tangible method to preserve wealth in a world where the value of paper currencies is constantly being eroded by inflation.

Investment in gold can be done in a few ways. The most straightforward of them is to buy physical gold. Investment-grade bullion can be purchased from traditional or online retailers. Buyers, however, would have to exercise caution to ensure the purity, authenticity and conditions of the gold they intend to purchase. Moreover, the monetary costs of storing physical gold with a high degree of safety should be taken in consideration when making such investments.

Another avenue to invest is having a gold passbook, which is an account for customers to buy and sell gold without physical settlement. Such services are usually offered by financial institutions whereby one may trade gold without having to hold and move the physical gold. As prices are determined by individual banks, the absence of an efficient price discovery mechanism makes gold passbooks less consistent with spot prices.

The next is exchange traded funds (ETF) that are backed by gold, which do not come with the limitations mentioned. ETFs are actively traded in an open and liquid market, where there is an efficient price discovery mechanism to narrow bid-ask spreads. However, like most other financial products, gold ETFs incur certain transaction costs, and only allow investors to profit from rising markets, which makes gold futures a more flexible alternative.

Like ETFs, gold futures are traded on transparent and liquid exchanges, where prices closely track spot prices and bid-ask spreads are narrow. Without having to safely carry and store the physical commodity, investors are able to seek exposure to gold by trading futures contracts with low transaction costs. Unlike ETFs, investors are able profit from both rising and falling prices by going long or short on gold futures respectively. Additionally, while some ETFs offer up to a 4:1 leverage ratio at most, investors may control as much as 15 to 20 times the value of an underlying instrument with a futures contract.

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Conclusion

The economic uncertainties of such an unprecedented scale the world is facing today are compelling investors to seek new avenues to maximize their returns while effectively managing risks. In order to do so, one should move beyond holding cash as a safety net, seek higher returns from a more thorough diversified allocation, and at the same time managing risks.

Kenanga Futures offers brokerage services for COMEX Gold futures traded on the Chicago Mercantile Exchange (CME), and the ringgit-denominated gold futures contract traded on Bursa Malaysia Derivatives and global exchanges derivatives products such as index and commodities futures contract at competitive rates. Please e-mail to us at futures@kenanga.com.my or call our dealing desk at +603 2172 3820 for further inquiries.

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