01 May 2020
There is obviously a huge amount for people to digest at present – both personally and in terms of markets and economics. Just a month after the S&P 500 hit a record high on 19 February, the ongoing spread of Coronavirus and an oil-centred dispute between Russia and Opec has seen markets tip into bear territory and growing fears about impending recession.
Amid huge daily declines in stock markets, we have seen emergency policy responses from central banks in cutting interest rates and providing much-needed lines of credit and liquidity – and with many businesses threatened as countries enter lockdown periods, much more of this is to come.
Looking to the next few weeks and months, there clearly remains a huge amount of uncertainty and it is imperative we avoid the panic that has overtaken markets. Without being flippant, this is not the end of the world however and things will recover – market participants are currently attempting to bridge the gap between reality and perception when it comes to the ultimate impact on growth and that will lead to abundant debate over U versus V-shaped recovery and other letters beyond that.
As would be expected, Coronavirus fears led to a collapse in investor sentiment over March and large-scale selling of equities, despite efforts by many fund managers to urge against panic and crystallising paper losses. Looking at Bank of America’s latest monthly Global Research Report, this backdrop has seen the largest drop in equity allocations, with 35% of investors now underweight the asset calls, with many rushing wholesale into cash.
However hard it might be against this tumult, it is vital to remember a few basic investment lessons and avoid short-term mistakes that can potentially damage long-term wealth generation. This will be the fourth bear market of my investment career and while the catalysts are always different, there are clear similarities that we expect to emerge this time as well.
Without diminishing the severity of current conditions, it is useful to put dramatic, short-term events into a long-term perspective. Economic conditions may change over time but the emotions of fear and greed are a constant factor in daily market moves. Over Monday 19 October and Tuesday 20 October 1987, the FTSE 100 fell 23% as Black Monday hit, but over the subsequent five years, it produced a total return of 74.8%.
As we have said many times, equity markets rarely ascend in a straight line and successful investors know to expect corrections and bear markets on the path to long-term reward: the vital lesson is not to panic and stick to your strategy. Our focus remains on patient investing – the winning by not losing we talk about so often – and what that ultimately requires is the ability to look through short-term periods and keep faith in the long-term process.
As would be expected against such an unprecedented backdrop, the portfolios saw a significant drawdown over the first quarter, although this should be seen in the context of the worst three months since 1987 for the FTSE 100, what we call the ‘News at Ten Index’.
Once again, the benefits of diversification are clear from Q1 returns, with the handful of funds posting positive numbers across the range largely fixed income vehicles, including Legal & General All Stocks Gilt Index, Vanguard Global Bond Index and Royal London Global Index Linked. Bonds would be expected to outperform amid panic selling of risk assets but the sheer scale of yield declines has surprised many market watchers, particularly in gilts.
Looking at our equity exposure, there are few surprises, with UK funds typically among the worst hit – Fidelity Special Situations for example – amid a range of double-digit falls. As emerging market and Asian equities have done relatively better than Western equities over the quarter, the higher-risk portfolios have benefited from their greater exposure to these.
We remain in close contact with our underlying fund managers and although they are all watching markets as we are, we are comforted – as odd as it might sound – that most are currently doing very little, at least in terms of buying and selling.
All our managers are selected on the basis they have successfully kept to a certain style over the long term and any sudden shifts in approach now would raise a red flag. What we are seeing them do is revisit their portfolios to ensure the case for each stock remains intact and we would expect many to take advantage of cheap valuations in the months ahead.
In terms of our own tactical asset allocation, we have been neutral since October 2018 when we pared back our US equity exposure, favouring areas where we see the best value – namely Europe, Japan Asia and emerging markets. We have also maintained a weighting in bonds for diversification, with a bias towards credit and high yield, and alternatives via hedge funds and absolute return vehicles.
At any point in time, our tactical positioning ranges from one to five, with one the most bearish on markets and five the most positive. As stated, we have been neutral since 2018 and feel that gives us scope to take advantage of increasingly cheap equity valuations as we look forward.
Coming back to that huge monetary and fiscal stimulus package, we would suggest trillions of dollars poured into the US might bring an end to recent dollar strength for example and a period of weaker greenback would potentially be positive for emerging markets.
Meanwhile, if we go back to a similar period of government largesse, in the wake of the Global Financial Crisis, a major fear was that quantitative easing would spark inflation but, ultimately, the forces of globalisation and technology were enough to keep it in check. Technology is more embedded than it was then, however, and we might see companies increasingly eschew global supply chains and seek more local suppliers in a post-coronavirus world, both of which would put pressure on inflation.
Widespread onshoring would also have implications for issues such as climate change, and these are all things companies – and, of course, our underlying fund managers – will need to consider when we finally come out of these challenging days and can start looking to the future.
Buy low, sell high is one of the cornerstones of our strategy but data show the average investor continues to do the opposite. We feel the coming months will allow us to do exactly this while remaining within existing risk parameters and suitability requirements. We are not there yet but, looking back at this period in a year’s time, we would not want to rue missing a great opportunity to buy low.
The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. This article is for information only and should not be deemed as advice.