The Night Watch sheds light on murky markets

Markets & Research

January 26, 2021

A team of economists and analysts keeps abreast of developments during periods of heightened volatility.

Take a moment to study Rembrandt’s 17th-century masterpiece The Night Watch. In this remarkable painting, each of the detailed figures is gazing in a different direction. Every figure has a unique view, which gives the group a wide-ranging perspective on its surroundings.

Nearly 400 years later, The Night Watch is the inspiration for a multidisciplinary research team at Capital Group. But while Rembrandt’s subjects kept Amsterdam safe, our team maintains a steady watch on market disruptions and potential investment opportunities during times of extreme uncertainty. Not surprisingly, the group is now firmly focused on COVID-19.

Each Night Watch member is charged with keeping an open mind, considering possibilities regardless of their near-term likelihood and shedding preconceived notions. That approach can be simple in concept but difficult in execution. After all, stepping back from the frenzy of the moment — and the groupthink of the markets — is easier said than done. But Capital Group prioritizes such thinking, believing that multiple points of view are critical to unearthing insights that might not be immediately apparent.

“The goal of the Night Watch is to look at highly uncertain events, where the outcome is essentially unknowable, and study them from all angles,” explains Capital Group economist Jared Franz. “Like the individuals in the painting, we are looking out in all directions, evaluating possible scenarios and considering potential outcomes.”

This goes to the heart of the Capital Group Private Client Services investment approach, in which the diverse perspectives of investment professionals are combined with independent decision-making. The Night Watch doesn’t make investment decisions, but it helps inform the larger organization.

“One of the real strengths of the Night Watch and other multidisciplinary research groups is the fact that we have multiple views — or multiple eyes, so to speak — on each problem,” says John Queen, a fixed income portfolio manager at Capital Group Private Client Services. “When a crisis comes along, we already know the industries and the companies well, and we can act quickly.”

The Night Watch has a history of planning.

Though it might seem like the team came together for the unique challenge of the coronavirus, the group was actually formed in the aftermath of the 2008 global financial crisis. Night Watch has yielded numerous insights since then. For example, the team raised an early alarm recently over rising debt levels and deteriorating credit conditions in the U.S. corporate bond market.

That situation had its roots in the financial crisis, when ultra-low interest rates and central bank bond-buying activities allowed many companies to borrow vast sums at historically low costs. Even more worrisome, companies with relatively low credit ratings accounted for more than 50% of the market last year.

Corporate debt levels continue to rise

“We could see that soaring levels of corporate debt were producing an imbalance in the economy,” Franz says. “We worked closely with our fixed income team to quantify the downside risk in specific corporate bonds so they could make those investment decisions on a security-by-security basis.”

Now the group confronts coronavirus.

In its coronavirus analysis, the Night Watch is studying the pandemic from all angles and considering economic, market and health implications. The team has examined several recession and recovery scenarios, including V-shaped, U-shaped, W-shaped, L-shaped and even Nike-swoosh-shaped. The members put together a weekly dashboard to help track which scenarios are currently more likely.

Massive government stimulus measures have helped soften the financial impact of the virus, but elevated infection rates in many U.S. states have complicated the recovery effort.

“There’s still a lot we don’t know about the virus, and I think the next few months are going to be tough,” Franz says. But the recently encouraging news on vaccine development “bodes well for a stronger recovery in late 2021 or early 2022.”

Indeed, global equity markets are telegraphing such a recovery, given the extraordinary rally since late March. There have been similar — if less extreme — patterns historically; markets powered through previous disease outbreaks, including swine flu, MERS, Ebola and the Zika virus.

Investing during the COVID-19 outbreak has, in some ways, accelerated trends that were in place before the pandemic, such as the growth of e-commerce and cloud computing. The virus has hastened the decline of some companies that were already struggling to survive, such as traditional retailers. But it has also devastated some industries that were previously doing well, particularly travel and tourism, meaning the outlook is very much sector-by-sector and company-by-company.

Capital Group equity portfolio manager Anne-Marie Peterson says, “The Night Watch team highlights that we have an incredible group of researchers who evaluate these macro events on a very deep level, helping us to understand the risks and ultimately to act on the long-term investment opportunities that often emerge during times of crisis.”