Volatile Markets 23.03.2020

After discussion with our partners in the City, Square Mile, they will produce for us a weekly update of the investment markets as they see them in these difficult times. Afterall, they advise on a large proportion of our clients’ investments. The thoughts of the head of team Jason Broomer are below:

“Understandably people are concerned. Our streets look like something out of a Hollywood horror movie. The press is feeding on peoples’ fears and markets are panicking. Yes, this is serious, but it is something that we shall get through. It is never wise to underestimate humanity’s problem-solving skills and ability to adapt to new situations.

As investors it is important is to keep calm. Fear triggers our primeval ‘fight or flight response’.  Adrenaline surging through our systems is designed to marshal every fibre of our being into short term defence. When you are being chased by a lion across the Savanah, we are not wondering what we shall eat for dinner or where we shall holiday next year. Adrenaline is the enemy of long-term investing. Stress causes us to lose focus on the long term. We are fearful of Covid-19 and its possible impact on our loved ones. We are also concerned by what is happening in financial markets as our savings are ravaged. We cannot provide answers to what will happen over the coming weeks and months. However, it is likely we shall see great improvement in the outlook within a year’s time and life will return to something like normality within a couple of years. That is, if it is not before.

Events are moving at such great speed; it is difficult to mentally and emotionally adjust to what is happening. The quicker we can, the better we can make decisions that will aid us. Panic helps no one, let alone those who are panicking. Highly contagious diseases such as Covid-19 can quickly burn themselves out. We are long term investors, so we must not let events over the next year distract us from our objectives that are framed over the coming ten or twenty years.

Covid-19

It is becoming increasingly apparent that this virus, while serious, is not as deadly as some of the early figures suggested, as many cases seem to have gone unreported. Across the population the death rate is probably going to be around 1% for those infected. Whilst the haunting news of the death of the 34-year-old Li Wenliang, the whistleblowing doctor from Wuhan, sticks vividly in our minds, this seems thankfully an exceptional case. This is a disease that predominantly takes the old and the sick. Though all age groups remain at risk, and many will require hospital treatment, 99% will pull through. The Koreans have been assiduous in their testing and identifying all those who have the virus. I am no virologist, but looking at the mortality rates there, I reckon someone in my age group (I turned 52 on Thursday) has approximately the same risk as dying from Covid-19 as any other disease or accident that might befall me over the course of the coming year. According to the bandolier.org.uk website, UK men in the 45-54 age bracket have a 1 in 279 risk of dying through any year. I then considered the odds for my 90-year mother, where women aged 85 and over have a 1 in 7 chance of dying in any year, which is perhaps comparable to her fatality chances if she contracts Covid-19. This, I am sure, is an approach that only provides a rough approximation of the risks; however, others may find this a useful way to illustrate the risk that the disease brings to us all. Both my mother and I are lucky as we enjoy good health. Those with illnesses may need to adjust the numbers accordingly. Note that the majority of those even in the most vulnerable grouping will pull through if they are infected. We need to keep the risks of this epidemic in perspective and not be overly anxious.

The economy

Events are unfolding so quickly. The market reaction is as fast as it occurred in the darkest parts of 2008. Then, I was genuinely worried about the continuation of the financial system, we were over an abyss and we were a few days, or even a few hours, away from being unable to withdraw cash from an ATM. The current situation is a crisis, and an exceptional one, but we see no reason why it will not pass.

The economic impact of Covid-19 could be quite mild. However, our governments have decided, quite rightly in our view, to deploy some of our wealth to protect the health of the nation. There will be periods over the coming weeks where the normal functioning of capitalism is suspended. Imagine if you like, that gravity temporarily disappears, a simple exercise such as a trip to the shops now becomes a very different experience as we now float our way there. At some stage, gravity will be turned back on and things will be returned to normal. Economies will begin to function as they always have done. At some stage the worst of this crisis will pass, and our lives will return to a more familiar pattern.

The economic implications of the governments’ action to control the spread of the virus are profound. Demand for certain industries such as hotels, theatres and travel will collapse. It makes little economic sense to allow these entire industries to collapse. Governments are sensibly planning to help support them, keep staff on the payroll and when the disease is dealt with, consumers will begin to enjoy these services once again. Governments around the world are now hurriedly stepping in to do this.

We are now in a recession, and a deep one but hopefully it will not be lengthy. However, this has been a long economic expansion since the 08/09 recession. During this period excesses may have been built and these may now become more apparent. When the tide goes out, you find out who has been swimming naked. In 2008 it was the banks. In 2001, it was Enron, WorldCom and other corporate malfeasance. However, spotting landmines before they explode is difficult, by definition. We are keen to ensure that your portfolio is as far away from any likely blast zone as we can. We have concerns about large debt build ups in China and in some other areas. If trouble was to arise here, we are thinking through the chain of events that might ensue and double checking that your portfolios have little exposure to these areas.

Markets

Stock markets have crashed. Corporate bonds markets have slumped. The gold and oil price have fallen. Sterling has dropped to a 30-year low. Even government bond markets have sold off heavily over the last week as governments began to absorb the huge costs of fighting this disease. A few weeks ago, the FTSE 100 was trading at all-time highs, it is now a third less and at a level last seen in 2009. Even if you incorporate dividends, investors have had the last 7 years of gains wiped away. Thankfully, we run more diversified portfolios than this and for those with a middling risk portfolio, we have managed to limit the falls to a mid-teen loss, in effect going back to where these portfolios where around 3 years ago.

Over the last week or so, we are seeing some technical strains develop within the system. Our contacts in markets warn that the banking sector is struggling to push through the government support package. Perhaps we shouldn’t be surprised, for the last decade governments and regulators have been acting to ensure only cautious levels of lending take place. Now the need is for urgent and large flows of credit to be 

passed along. At the same time, the contraction in global trade has created a dollar funding issue. This is creating a technical shortage of dollars in the international payments system. Hence, we are seeing some stress in financial markets. We believe that the authorities will be able to manage to ease these strains and some of the extreme moves that we have seen in some markets will be reversed.

Markets are moving incredibly quickly. The moves of 5% or even 10% on a daily basis in equity markets are like nothing we have experienced in our lives. Some investors are panicking, others are stretched and forced to sell. Typically, these are the conditions when bargains are to be found. We sense that the sell-off in corporate bond markets have now reached an extreme, especially in view of the government’s aim to tide businesses over through this difficult period. The good quality businesses that we lend to are unlikely to go bust, yet some are now being priced as if they might. This suggests to us that markets may be approaching their lows, although this is highly dependent on the direction that the fight against Covid-19 takes and whether any other problems arise.

The outlook

Trying to call the bottom in turbulent markets is impossible. However, markets are now discounting a great deal of the worst possible outcome. Valuation metrics in situations such as these become highly problematic, as companies’ profits degenerate into losses. However, one more reliable indicator is dividend yields. Companies rarely cut dividends in the UK and it scarcely ever happens across the entire market. Dividends across the market were cut in 2008/09, but only marginally so. Dividend yields in the UK are over 6.5%, this is very generous compared to the returns on offer from cash and government bonds, even if we factor in a sharp dividend cut across the market.

Our policy has been to dribble money into stock markets, we have done this twice so far in the month. Where prices currently are, we were too early. We are confident that in a few years’ time, we may well look back and conclude that these purchases were well timed. We have further potential to add to equities and we aim to do so over the coming weeks. In the very near term, markets are moving so quickly that we cannot be sure at what price we will be committing your funds to when buying stocks. Once markets return to a calmer state, we are likely to become active once again. Markets do not go on panicking indefinitely.

Summary

The current situation is worrying and very trying. However, we must take advantage of our long-term investment horizons and look through the uncertainties that we face over the coming months. We are sure that many of our current concerns will be firmly behind us in a relative short period of time. We are happy to bet on human resourcefulness and ingenuity in order to deal with our current problems and allow us all to flourish in the years after this crisis has passed.

Simon’s views

We are completely in agreement with what Jason’s has written. The overall message is that properly diversified portfolios will see us through this and give us the opportunity to try and take opportunities as they arise. We will continue to update our clients regularly as and when we think it is helpful. There is a lot of noise out there and we hope that you will see these updates as good common sense amongst the general panic.

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