What Now for Treasurers and Corporate Investors?

  • SANJAY CHAWLA SENIOR VICE PRESIDENT AND CHIEF INVESTMENT OFFICER, FM Global, Treasury & Risk; MARCH 8, 2021

It’s a new year, with a new government managing a new phase of the COVID-19 pandemic. Should treasuries also have new plans for 2021?

Most signs point to a good year for investing, as the United States is turning the corner on vaccinations, the federal government is supporting pandemic recovery, and emerging markets present reasonably attractive opportunities. This forecast has several implications for corporate treasurers. One is that it’s time to start taking some risks again.

Certainly, 2020 was an enormously challenging year for many U.S. businesses, but it wasn’t quite as bad as first expected. The Federal Reserve came to the rescue of financial markets in March 2020, helping corporate treasurers and CFOs raise a lot of cash as they drew on their corporate revolvers, issued commercial paper, and raised debt financing through record corporate bond issuance. Notwithstanding bankruptcies in some sectors, the overall rate of business survival was higher than we feared early last year.

The corporates that survived the first six months of the pandemic were understandably risk-averse, so they essentially sat on much of the funding they raised. While this was the right thing to do at the time, it has become important to start putting that cash back to work in the business via research, capital expenditures (capex), and innovation.

Treasury groups should be investing the remaining excess liquidity in ways that take prudent risks—with the goal of improving investment returns on the larger-than-ever amount of cash on their balance sheets. To increase yields, corporate investors need to move further along the risk curve, while keeping these corporate cash investments in high-quality money market instruments. This is prudent because sitting on cash has a drag on a real inflation-adjusted basis.

Short-term corporate investments may include high-quality commercial paper and some short-term high-quality municipals, as well. AAA-rated securitized assets also help enhance yield expectations. Their downside risk is reduced due to the credit enhancement, and they increase diversification. Corporate investment managers may also want to allocate a small portion of their excess cash to high-quality short-term emerging market currency debt, as predicted U.S. dollar depreciation would increase the potential returns from such investments.

All that said, corporate treasurers and chief investment officers must ensure that their investment managers perform the necessary bottom-up and top-down due diligence before putting corporate cash in any new asset types. Yield and diversification are important, but they can’t take precedence over preserving the company’s cash, which is the treasurer’s primary responsibility.

Specifics of the Investment Outlook

Evaluating the external environment before making any corporate investments is more important now than ever before. After what we’ve endured over the past 12 months, I think there is good reason to be optimistic. There are favorable signs in public health, public policy, international cooperation, and global growth. We’ve witnessed an unprecedented pace of medical research, and the world has adjusted to navigating through the health-crisis risks patiently and favorably on the whole.

Several economies have shown remarkable resilience and have paved the way for what recovery looks like in a post-COVID-19 environment. Overall, the global economy seems to be headed for a desirable V-shaped recovery, with growth between 5% and 6% projected for 2021, following 2020’s sudden contraction. I expect short-term and policy interest rates to remain low around the world, while long-term rates move higher as economic growth improves and inflation rises.

I also expect to see better global cooperation, which would benefit global economic growth. With the monetary and fiscal stimulus across the globe, especially in the United States, and a path to vaccinations and economic recovery, 2021 is likely to be another positive year for global equities.

Here is my take, as the chief investment officer for a global commercial/property insurer’s investment fund, on some of the details of how 2021 is likely to unfold—as well as on how those changes should inform corporate investment managers’ asset allocation, cash management, and preservation and growth of organizational capital.

The Biden-Harris administration. In my view, the U.S.’s new presidential administration is having a positive impact on the investment climate. While some worry that this administration will increase regulation and raise taxes (both negative for equity markets), I expect growth in spending to more than offset any negatives. In light of Democrats’ ambitious agenda coming off wins of both Senate runoff races in Georgia, I expect that both tax revenue and government spending will hit levels under this administration (as a percentage of GDP) that we haven’t seen in decades.

The next round of stimulus is close to passing and should spur an uptick in consumer spending. And although the administration’s sharper focus on the climate could mean new regulation and taxation, green energy will almost certainly be a pillar of any new infrastructure spending proposal. Such a bill would likely pass, thanks to the Democrats’ majorities in both chambers of Congress.

Moreover, I think the Biden-Harris administration increases the potential that the United States will restore international cooperation on key issues including climate and environmental concerns. On the other hand, the increasingly adversarial tone of relations between the U.S. and China cuts both ways for investors. As long as China and the United States maintain separate technology ecosystems—for example, 5G wireless connectivity—that division adds complexity to global investments. But on the positive side, the U.S.–China rivalry could spur new innovation around the globe.

Vaccinations.  When the pandemic began, it was clear that progress on vaccines and therapeutics would determine the timing of a global economic recovery. Anyone who said at that time that a vaccine would be in distribution by January seemed overconfident based on typical medical research and development timelines. But in early March, three vaccines are here. There have been bottlenecks in the U.S. rollout, but it seems likely that everyone who wants a vaccination may be vaccinated by summer.

The markets are largely reflecting this good news. Sectors and companies that will benefit from the economy’s reopening are seeing a V-shaped economic recovery priced into their valuations. That said, some markets may be getting ahead of themselves. Certain sectors and companies are more likely to see a gradual recovery. For example, there is every reason to expect that the pandemic workplace will permanently reconfigure how we work, and there are risks in that. What, for example, will be the future of business travel?

The K-shaped recovery.  At the individual-business level, the dispersion we saw in 2020 among sectors—and even among companies within the same sector—was unprecedented. After the initial across-the-board dip in business activity and stock prices last March, sectors split like the arms of the letter K. Some fortunate businesses not only rebounded but soared past their baseline revenues and profitability. Technology, logistics, and e-commerce companies are common examples, and those sectors are expected to continue to do exceedingly well as we find the next normal.

As the global economy reopens in the second half of this year, cyclical businesses that underperformed during the COVID economy will continue to recover, as the energy sector has recovered from the lows. In terms of stock price performance, technology and consumer discretionary sector companies are expected to outpace energy, materials, and industrials in the long term, given the structural changes in the operating business environment. On the other hand, I think companies in the financial services sector will do better than has been priced into the market, as the large banks in particular showed tremendous resilience during the economic and financial uncertainties in 2020.

At the consumer level, the K-shaped gap is even wider. Income inequality was pushed to new levels in 2020. While many in the hospitality and travel industries lost jobs, those who rely heavily on technology often generated better-than-expected results in a work environment that had been adjusted for lower expectations.

Tax policy.  In 2020, markets recognized the possibility that a blue wave might lead to an immediate increase in tax rates on capital gains and corporate profits. There was concern the potential tax hikes would come in early-to-mid 2021 and be retroactive to the beginning of the year. Markets braced for that possibility and stayed in check in Q3/2020 and early Q4/2020, in anticipation of selling.

Although I still expect taxes to increase, that likely won’t happen until 2022 at the earliest. The US$1.9 trillion stimulus is the immediate priority. Expect another major spending wave in the second half of the year that focuses first on green infrastructure, and afterward on healthcare reform.

Emerging markets.  Global economic growth dropped sharply just about everywhere in 2020, but there were disparities in degree. The drop in developed markets was more pronounced than in emerging market economies. A primary reason was that these countries deftly managed COVID-19 outbreaks. China, South Korea, Taiwan, and Singapore were able to quickly reopen their economies, albeit cautiously and safely. In fact, China was the only major economy to deliver positive economic growth for 2020.

In 2021, growth in emerging markets—especially in Asia—is expected to outpace that of the developed world. Most of these economies are poised for a strong recovery. China’s GDP is expected to grow by 8% or 9%, and India is poised to grow in the range of 9% to 10%. Russia and Brazil are also expected to experience GDP growth this year, but at a lower 2% to 4%.

Additionally, I expect more foreign capital to be directed toward emerging markets. Capital is plentiful and is looking for attractive and safe investments. Given the valuations of emerging market assets, and the optimism on growth, emerging markets seem a natural destination.

Interest rates.  The Federal Reserve has indicated that policy rates will remain low for the foreseeable future, most likely lasting through 2023, at least. In addition, Chairman Jerome Powell has indicated that there is no risk of tapering later this year.  Since the economy currently remains fragile, monetary policy with a lower federal funds rate is expected to remain supportive for an extended period of time.

That means continued low interest rates throughout the economy, also maintained through fixed-income asset purchases by the Federal Reserve. With Janet Yellen, former Federal Reserve chair, now at the helm of the U.S. Treasury, we will see even better coordination between the U.S. Treasury and Federal Reserve. These favorable, coordinated monetary and fiscal policies are intended to pull the U.S. economy up from the catastrophic damage caused by the pandemic. This process will take some time, as it remains to be seen what the “next normal” will look like from a business and consumer behavior standpoint.

For now, longer-term interest rates have moved up, as markets fear that excess liquidity meeting renewed consumer demand will result in inflation. There is also some fear of early Fed tapering due to the reopening of the economy, which might result in inflation sooner than what the Federal Reserve has communicated. This concern resulted in skepticism in the bond market, which was reflected in the price action in late February, resulting in higher longer-term interest rates.

Still, interest rates in the big picture remain low. With credit spreads very tight, the outlook for bonds and fixed income is flat to marginally positive or negative.

Risks Remain, but I’m Mostly Optimistic

There are risks in this environment. Vaccinations may not progress as quickly as planned. New, fast-spreading virus variants may be difficult to control. U.S.-China relations may devolve, with uncertain consequences. Further, we may face risks we’re not currently aware of, such as bubbles in asset valuation and leverage or higher-than-expected taxation.

Nevertheless, based on the COVID-19 progress to date and businesses’ successful navigation of the crisis thus far, many executives and market analysts feel the pandemic’s risks have peaked. We have a visible path to recovery, ample liquidity, and a ripe new area of investment around environmental, social, and governance (ESG) opportunities.

As a chief investment officer, I continually weigh the opportunities, risks, and conditions impacting financial markets. At this time, as you can tell, I lean toward optimism for investments. The various building blocks line up for a strong case of adding measured risk to the portfolio.  There is tremendous liquidity in the markets that are looking for attractive investments. The size and pace of adding on to selective and prudent opportunistic investments in a timely manner—while avoiding any market excesses—will be key to investing the excess cash for investment managers and treasurers.

As originally published in Treasury & Risk.


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