It’s hard to know which are the more striking headlines in these pandemic-impacted global markets.
It’s the March headlines encapsulating the fastest, most vicious bear market and quickest collapse in economic output since World War II,
It’s the April headlines describing the strongest stock market rally in 45 years, foretelling that investors are about to experience a ‘V-shaped’ recovery starting this summer.
The bear case
For the market bears, the collapse in GDP and economic slump caused by Covid-19 will have a major impact resulting in a fixed loss of economic output and a fundamental change in the way we live our lives … from human interaction to the way governments and business behave. Simply put, in economic terms, this will result in a permanent shift from capital to labour which, while arguably good for society, will be bad for stock markets and holders of financial assets.
The bull case
For the bulls and optimists, they see a V-shaped recovery post-virus, with output and profits soaring as households and businesses revive, supported by government spending and a global US$5tn of stimulus. This group is ultimately cynical of the claims life will change and believe that the global economy will bounce back quickly. So, buyers of assets today will profit hugely from buying assets at these levels and ‘FOMO’ means BUY now.
The truth, as ever, is probably somewhere in between
Economic events are rarely ‘totally’ catastrophic even when the human consequences are terrible (think 9/11, the outbreak of WWII and the Spanish flu pandemic of 1918). All saw stock markets higher beyond the immediate crisis.
For us at South River, as has been the case since the start of 2020, we err on the side of caution and prefer a diversified approach to investment.
Our 2020 outlook
In our 2020 market outlook published on 20 January we wrote: “Euphoria over the US/Sino trade truce and a backdrop of accommodative global central bank policy notwithstanding, we are decidedly cautious on the outlook for 2020, believing that much of the good news is already priced into financial markets. Data stretching back one hundred years show every single year ending in a zero has resulted in a down period for the important US equity markets.This has proven the case irrespective of whoever had been elected president.
We also wrote, “Roadblocks lay ahead. At the time of writing, China is on high alert over the spread of the highly contagious coronavirus. Economically, we are over ten years into an uncomfortably long economic cycle. With investors factoring in global earnings growth of ~8-9%, companies are going to have run hard to keep up the pace, both in terms of growing sales and preserving margins. Decidedly flat yield curves are already indicating that might be no easy task.”
And we concluded what this meant for portfolio strategy: “In terms of what that means for portfolios, we believe equities look overvalued relative to historic levels, while sovereign and corporate bond yields are decidedly overbought. We are more positive on the prospects for EM high-yield debt. Mexican and Russian high-yield debt may look optically expensive but Russia’s net debt level to GDP currently stands at 20%. Given the comparative health of its balance sheet, 7% bond yields look attractive in our view. We like gold and precious metals and commodities more generally are undervalued in our view. “
Our cautious stance in January 2020 was warranted
Our caution was based ironically not on a pandemic (although we did allude to this as a possible trigger for a setback) but fundamentally on “over-rich valuations”, rapidly slowing global GDP and an associated earnings slowdown, and an outsized return on equity that we believed would fade. The coronavirus outbreak which we pointed out as a potential catalyst was just one of several catalysts that might have been a trigger for a market drop but in truth it was one of many. We stick with this fundamentally cautious view.
However, short term, and with equity markets oversold, we believe there is still the chance that this vigorous rally will gather momentum for a little while longer. Nevertheless, fundamentally we believe markets remain high risk and we maintain a focus on liquidity, quality blue-chip income and those investments with largely defensive characteristics.
The South River funds are performing well and Cautious funds in particular have been resilient, with values of the three Cautious funds only slightly down year-to-date and performing well against their peer group comparisons. (see post below).
Regarding the outlook, fundamentally one of the things we feel most sure about at SRAM is that corporate debt (the asset class between short-term government debt and equities) needs to recover first.
The US Federal Reserve’s statement last week that it was to include high-yield bonds in a further US$2.3tn of liquidity it was providing to the market gave substance to this view and we believe they regard this as critical to any recovery.
Trading wise, we did take advantage of depressed values in the March sell-off via our high liquidity position by adding to several quoted investment trusts and exchange traded funds that, we believe, meet our strict criteria for a margin of safety, liquidity and yield:
EDINBURGH INVESTMENT TRUST
NB FLOATING RATE INCOME FUND
iSHARE OIL EXPLORATION AND PRODUCTION ETF
iSHARE METALS AND MINING ETF
STARWOOD EUROPEAN REAL ESTATE LOAN FINANCING
iSHARE EMERGING MARKET DEBT FUND
iSHARE EUROPE UTILITIES ETF
iSHARE EUROPE PROPERTY ETF
All of these combine defensive characteristics of decent asset backing with an ability to generate recurring coupons or dividend yield.
Meanwhile, on a more light-hearted note, it’s surely worth asking the management team at Netflix if they could at least screen something semi-decent. The share price may be at an all-time high, and I don’t know about you reader, but crumbs do the kids and I think they need some new content!
Q1 2020 returns (net % as at end March 2020)
|3 months||12 months|
|JPM Global Bond Index (US$)||9.0||11.5||16.4||14.2||16.9||20.0|
|JPM Global Bond Index (£)||0.2||2.5||7.0||5.5||8.0||10.9|
|BofA Global Broad Market Corporate||-5.6||-3.4||0.9||1.1||3.5||6.2|
|BofA ML £ Non-Gilts||-9.4||-7.3||-3.2||-3.2||-1.0||1.7|
|BofA ML Global High Yield||-14.1||-12.1||-8.2||-8.3||-6.1||-3.6|
|MSCI Emerging Markets||-23.6||-21.8||-18.4||-17.7||-15.8||-13.5|
|MSCI AC Asia ex Japan||-18.4||-16.5||-12.8||-13.4||-11.4||-9.0|
|FTSE Europe ex UK||-22.8||-21.0||-17.5||-12.4||-10.4||-8.0|
Source: Thomson Reuters DataStream as at end March 2020.