Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
View from the very top: keep calm and carry on (or at least try to). What makes the current situation so concerning for investors is its sheer unpredictability. All bets are, arguably, off in terms of impact to economic demand and hence to corporate health (particularly credit). How policymakers respond is also unclear, although the use of unconventional fiscal tools seems increasingly likely, even if this may have future adverse unintended consequences. Unprecedented times often call for unprecedented action. While there is a tendency to be seen to be active, our counsel is to slow down. Often the best strategy can be to do nothing. That said, we see a strong logic in avoiding higher risk areas of the market (financially stressed businesses) and also in considering increased allocations to safer havens. Out of every crisis opportunities do of course emerge for the longer-term.
The movements in all asset classes witnessed in the last few weeks is eerily reminiscent of what occurred during the height of the credit crisis. Perhaps investors should not be surprised. It had been easy to become conditioned to abnormality and to the expectation that in times of difficulty Central Banks would be there to step in. However, context matters. Volatility has been exceptionally low for a long period of time. More significantly, consider that the world neither experienced an economic recession nor an equity bear market during the past decade. For the US at least, there has never been a prior decade in its history as a nation (i.e. since the late 18th Century) when this has occurred. All good things have to come to an end. Mean reversion is a powerful and necessary force.
What makes COVID-19, or the coronavirus, so very worrying – apart from the human health consequences – is that its impact is so impossibly hard to quantify. In many ways, it can be seen as a classic ‘black swan’ event; namely something that has come as a clear surprise to the world and has been inappropriately rationalised. The media frenzy – or border hysteria and misinformation – has only served to compound the problem. Metaphors do have a strong ability to shape narratives. Moreover, like viruses, narratives often spread then dissipate, perhaps at a similar speed to pandemics. Uncertainty surrounding the virus has created a clear information vacuum for investors.
The danger, of course, is that fears of a recession or any other reset (be aware that some equity markets around the world have already dropped more than 20% from their peaks, hence reaching bear territory) become self-fulfilling prophecies. Even if they don’t, all assumptions regarding the impact of the virus on demand, supply chains or credit need to be questioned strongly. It is perhaps not unfair to wonder how far the world may be from the ‘moment’ warned of by the much-underappreciated economist Hyman Minsky; when one domino falls and then the rest tumble.
Policymakers will naturally look for solutions. Monetary stimulus has all but been used up as a potential outcome. Interest rates are at record lows in almost all geographies around the world. Meanwhile the recent 50-basis point cut implemented by the Federal Reserve in the US suggested more panic than precision. Investors were perhaps entitled to wonder that if the Fed acted in this fashion after only a 10% fall in the S&P 500 Index, what may it now have to do given that the market is markedly lower. In broader terms, monetary loosening may not be the best tool to fight what is essentially an exogenous shock to the financial system.
If not monetary aid, then what about accommodative fiscal policies? Less than a year ago, few would have countenanced such action (particularly in the form of ‘modern monetary theory’), but it now seems a virtual inevitability. As with quantitative easing a decade ago, fiscal stimulus – whether in the form of payroll cuts, infrastructure projects, ‘helicopter money’ or indeed any other approach – will have consequences, both intended and unintended. Such actions may prevent an outcome worse than might otherwise have been the case, although this will probably only be known with hindsight. We should also throw into the mix the impact of a lower oil price (now at roughly half the level where it began the year), which will likely have a positive benefit both for some consumers and businesses. Gauging its true impact will, of course, be hard.
In this environment there is a natural tendency for investors to be seen to be active. Timing markets is, as we all know, close to impossible. It is also important not to conflate reactive with pre-emptive behaviour. Things may well get worse before they get better. At the least, newsflow remains highly unpredictable. Our counsel, therefore, is not to panic and to slow down. Often the best strategy is simply to do nothing.
From an asset allocation perspective, we see clear logic in some strategies: avoid high-risk areas of the market and favour more defensive safe havens. In terms of the former, businesses with highly leveraged balance sheets and/or onerous working capital requirements look badly placed. Both their credit and their equity may be pressured. On the flipside, currencies such as the Japanese Yen and Swiss Franc have continued to show stability, for now. While there is a broader – and natural – tendency to reduce risk in times such as this, we believe that the current uncertain environment will demonstrate the benefits of truly active management and also of having exposure to genuinely differentiated asset classes. For the longer-term investor, out of every crisis opportunities will clearly emerge. For now, it’s important to be patient.
Alex Gunz, Fund Manager, Heptagon Capital
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