Of the potential risks we foresaw in 2020, we cannot pretend we had identified the outbreak of a new virus that would cripple the world for weeks, possibly even months but, beyond the sadness of the death toll and the dramatic impact on millions of people’s lives, we are left trying to assess the impact of this outbreak on the global economy and financial markets.
We still face several unanswered questions:
- How long will it take before the virus’s spread is curbed?
- For how long will safety measures hinder economic activity?
- What will be the magnitude and duration of the impact on economic activity?
The answers to these questions range anywhere from “relatively quick and benign” to “long and significant”, and currently it is impossible to provide any answers with a high degree of certainty.
The potential impact of a severe and sustained lockdown of large parts of the Chinese economy does not yet appear sufficient to trigger a global recession. Global recessions are actually very rare with the world suffering from one of those only twice since World War II. The most likely scenario in our opinion is one of a rebound in Asian economic activity after a temporary sharp drop. Moreover, the monetary policy easing put in place in China and across most emerging markets (and now being followed in developed markets, too) will provide support and liquidity in the weeks and months ahead.
Therefore, our constructive scenario for global growth is that we will see a sharp pull back in the next few months with the resumption of the positive trend towards the end of the year.
While all stock market crashes happen for different reasons, the one thing that is very consistent is how human nature plays into it. We believe there are three stages of behaviour when the market crashes:
- Panic – happens toward the end of the initial crash such as what occurred on Monday and today.
- Relief – develops after the crash with a reflex rally as investors are simply glad it stopped going down.
- Demoralisation – when the market tests the panic low and even breaks it.
Many would say it is different this time as we have never seen a pandemic play out the way COVID-19 is closing the global economy, and that is true. It is also true that, in 2011, a surprise rate hike by the ECB wreaked havoc on the weaker European economies, and subsequent sovereign debt dislocations in Portugal, Italy, Greece, and Spain caused fear of a global shutdown due to credit. In other words, crashes happen and true panic sets the stage for how the intermediate-term bottoming process should play out.
In terms of action we have undertaken the following changes to portfolios in the last two weeks:
- We took some profits in Primary Health Properties across the majority of portfolios by trimming part of the position. We were concerned that, in the short-term, healthcare facilities may be overrun and the company’s ability to negotiate higher rents from primary health practices may be compromised by the potential strain from COVID-19 on national health systems in the U.K. and Ireland.
- We trimmed back some of our U.S. Treasury Bond exposure in cautious portfolios as yields fell sharply (prices rose). The 30-year U.S. Treasury now yields sub 1% which to our mind is very expensive.
- We halved the 10% position in gold in cautious portfolios. Gold has performed very well over the last 12 months, but it is not a vaccine for COVID-19. In other words, we question its safe haven status in these unusual times, particularly as jewellery demand has dried up. As such, we saw no harm in taking profits with a view to reinvesting the proceeds in more conventional assets with better long-term prospects.
Our view remains that the best hedges against any potential further market downturns remain government bonds. We have seen this work well in portfolios so far this year and we continue to hold positions in both U.S. and U.K. bonds. We also continue to hold cash. We see little merit in reducing our commitment to equity markets at present and will be ready to reinvest cash when the time is right.
Please do not hesitate to get in touch if you have any questions or concerns.
Quartet Investment Managers – 12th March 2020