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The novel coronavirus that causes the illness poses an existential threat not experienced, outside periods of war, for more than a century. It is almost inevitable, statistically, that many readers of this report will develop symptoms of varying levels of severity, and also that some will experience loss of life amongst those near and dear to them. Even so, our clients’ financial health remains a priority for us, and, as usual, I will lay out the main factors that have driven market performance as well as our view of the future – for however much we are currently bombarded with depressing news, we are confident that this is a temporary cycle rather than a permanent state.
There were, prior to this episode, two hundred and fifty-six viruses known to affect humans, with most of them contained either by herd immunity or vaccination.The story of the first quarter of 2020 had its beginnings in December 2019 in a wet market in the city of Wuhan in the Chinese province of Hubei. It was here that a novel coronavirus made the jump to a human from an as yet undetermined animal host (although there are several suspects, including bats). There were, prior to this episode, two hundred and fifty-six viruses known to affect humans, with most of them contained either by herd immunity or vaccination. The reason that this new virus, SARS CoV-2, was so dangerous was that nobody was immune to it, especially as it turned out to have a high infection rate, leading to exponential growth in the number of cases if not contained.
The reason that this new virus, SARS CoV-2, was so dangerous was that nobody was immune to it, especially as it turned out to have a high infection rate, leading to exponential growth in the number of cases if not contained.
The high infection rate of the virus meant that healthcare facilities were going to be overwhelmed if nothing was done to check its spread. This led to the current situation of social distancing and self-isolation, which is creating a demand shock of hitherto unseen proportions. Even during the financial crisis one could drown one’s sorrows with a trip to the pub or a restaurant, but even those simple pleasures have been withdrawn, along with all public gatherings.
At one end of the scale two million flights had been cancelled globally by the end of March, with both airlines and airport operators seeking financial support.The net effect of all these constraints will be a global recession of epic proportions, with the attendant risk to corporate profits, balance sheets, and, crucially, dividend payments. Of course, the pain will not be felt equally. At one end of the scale two million flights had been cancelled globally by the end of March, with both airlines and airport operators seeking financial support. At the other end, grocery sales in the UK jumped a record 21% in March as everyone filled their cupboards with provisions.
Companies offering online entertainment and connectivity have seen booming demand. Even in tough times there are always relative winners. In aggregate, estimates now suggest falls of 30-50% in earnings per share for 2020 as a whole, although pinning down an exact number is well-nigh impossible, especially when companies themselves are withdrawing profits guidance owing to the uncertainty. There could conceivably be no earnings whatsoever in the second quarter for the market as a whole.
Economists are still hurdling over each other in a “race to the bottom” to pin down GDP growth (or more accurately decline) forecasts. There seems little doubt that the second quarter will define the trough of activity, given that virus containment measures do appear to be reducing the incidence of new cases. We could see falls in activity of well over 10% in many countries. Global GDP forecasts for the year are currently homing in on the level of minus 2%, although this is by no means a floor.
Much uncertainty remains about the slope of the recovery. Initial thoughts rallied around a ‘V’-shaped recession, but now a ‘U’ is gaining ground, or possibly a more drawn out recovery. Much will depend on how well contained the virus remains once social distancing policies are relaxed.
If serological antibody testing is introduced quickly and widely, people who have been exposed to the virus and acquired immunity (while possibly experiencing minimal symptoms) might be allowed to resume normal activities. A vaccine would be the “silver bullet” solution, although most experts believe this to be as long as twelve months away. Even so, with the world’s pharmaceutical resources assembled to focus on a single target, there are grounds for optimism, and regulators will fast track potential winners.
Much uncertainty remains about the slope of the recovery. Initial thoughts rallied around a ‘V’-shaped recession, but now a ‘U’ is gaining ground, or possibly a more drawn out recovery.
Of course, all this fiscal support means a potential explosion of government debt. In the past this might have been seen as cause for further alarm, but now seems a lot more like what many had been clamouring for anyway, perhaps under the label of “Modern Monetary Theory”, itself a way of describing debt monetisation, whereby government bonds are largely bought by central banks. Japan has effectively been doing this for years. The Bank of Japan has also been implementing what it calls “Yield Curve Control”, meaning that it acts in the market to suppress government bond yields. Even if there is not yet an official policy elsewhere, there is much talk of such measures being introduced more widely. There are questions being asked as to whether all this monetary and fiscal stimulus will finally release the inflation genie from the bottle in which it has been trapped for years. Given the countervailing disinflationary forces of technology and demographics (and the unknown after-effects of COVID-19), this remains a thorny issue. However, given that higher inflation is seen by many as the only antidote to the historically high debt burden, portfolios will need to carry some insurance against that risk. Gold has benefitted from such a prospect.
Finally in this section, some comment needs to be made about the violence of equity market declines in March. The S&P 500 index, for example, entered bear market territory (-20%) just 19 trading days after hitting an all-time high, a record of dubious distinction. The Crash of 1929 took a snail-like forty-five days to cover the same ground. The latter part of the recent decline, which took global equities some 35% from their peak, was exacerbated by what one might describe as a “liquidity event”, during which even safe haven assets, including gold and sovereign bonds, were sold almost indiscriminately. Some of this was investors selling whatever they could to raise cash in thin markets, some was selling forced upon investors by fund redemptions, but a large element, running into hundreds of billions of dollars, was sales by funds who scale the size of their investments through leverage according to the level of market volatility. As volatility rose, they had no option but to reduce the gross size of their funds. As best as we can ascertain, much of this phenomenon is now behind us, leaving investors to focus more on three prime fundamental factors in determining their actions: the evolution of COVID-19 cases and associated deaths; the influence of the response to the virus on economic growth; and the effect of these on corporate profitability.
Markets - UK
Where to head for higher returns? Inevitably that requires investors to take more risk. For those looking for an insurance policy that will pay out if equity markets fall owing to weak economic conditions, one would head further down the maturity curve where yields are higher. This longer-dated route still promises capital gains if yield curves flatten further, but the longer duration means higher volatility.
For substantially higher income, corporate bonds look more attractive, and following recent market moves, we now see value re-emerging in credit, where yield spreads have widened considerably owing to the risk of increased defaults. Central banks are providing a liquidity backstop to the Investment Grade market, and even in High Yield there is some belief that governments will not want too many companies defaulting or filing for bankruptcy with all the job losses that would entail. Equity holders will bear the brunt of the pain.
UK Gilts have delivered a total return of 6.01% over the last three months and 9.94% over the last year. Index-Linked Gilts returned 1.7% and 1.61% over the same respective periods. Emerging Market sovereign bonds produced a total return of minus 5.6% in sterling over the three months to end March (+0.23% over 12m). Global High Yield bonds delivered minus 5.6% (-3.61% over 12m).
Conclusion and outlook
We would argue that the biggest structural risks to the market have peaked, given that forced sellers have exhausted much of their supply and also because governments and central banks have once again played the “whatever it takes” card. However, cyclical risks remain, and we need to see more evidence of a flattening of the curve of new COVID-19 cases as well as a clearer view of the damage to the economy and corporate profits before taking on more risk in portfolios. It is also worth bearing in mind that the world economy’s own immune system is now weak. It was just recovering from the trade war before the coronavirus outbreak – and then the collapse in the oil price, thanks to a price war between Saudi Arabia and Russia, was another unwelcome blow. We can ill afford another extraneous shock now.
I am sure that there are several issues that have not been covered to everyone’s satisfaction in this report owing to word-count constraints. We encourage you to contact us with any further questions you might have. After all, what better time to show the value of a service and advice based business than in times of crisis.
About the author
John is Head of Investment Strategy for Investec Wealth & Investment UK, is a member of the Global Investment Strategy Group, and is Chair of the Investec & Investment UK Asset Allocation Committee. John graduated from Exeter University in Modern Languages in 1984. He spent 27 years as an institutional stockbroker with Merrill Lynch and Lehman Brothers, before moving to investment management in 2011 and joining Investec in 2013. John is an Everton FC supporter.