Chris Brown, CIO, 10th March 2020
Here is an update on the impact of Covid-19 on the markets and our portfolios. The one piece of good news is the containment measures taken by early victims of the crisis (including Singapore and China) look to be working. As an example, China reported 40 new Covid-19 cases yesterday compared to 46 in the UK and 1,800 in Italy. The bad news for markets is that these containment measures are extreme and unprecedented in the modern era of interlinked global economies. Also, countries where the outbreak is accelerating (like Italy) are having to put in place ever more draconian restrictions.
The impact of these measures on the global economy is therefore far greater than any previous virus outbreak. Economic activity in China dropped 80% in the weeks after the Chinese New Year as an example and is still well below normal levels. Covid-19 is acting as a short, sharp shock for the global economy and clearly certain sectors including airlines, hotels and restaurants will be particularly hard hit. Linked to the slowdown, the OPEC oil cartel were unable to agree on production cuts. This has pushed oil down to $30 a barrel (it was at $60 a few weeks ago). Partly because of this credit markets – always worried that the weakest players will not survive – have sold off sharply in the last few days.
All this means that recession risk is rising. One way to think about this is that (as at yesterday’s close) a 50/50 index of the UK FTSE All-Share and Global Equities is down around -20% from its January peak. Equity markets typically fall around -30% in a recession. The market is telling you there is roughly a 2 in 3 chance risk recession is on its way. The short term outlook is therefore significantly worse now than at the start of the year.
Looking out longer term, however, we think there are reasons to be optimistic. First, the virus is an unexpected external shock. The global economy was accelerating before it hit and we just do not see the normal imbalances or excesses today that would make it vulnerable to a deeper slowdown once the virus disruptions start to reduce. Secondly, lower oil prices, lower interest rates and the potential for fiscal stimulus should eventually set the stage for a solid economic recovery. Markets are forward looking. Once the uncertainty of the virus is reduced we think they will start to look forward to better growth in the future and start to recover this year’s losses.
When this will happen is much harder to say. Much will depend on how contained the virus is in Europe and (more importantly) the US. Testing has been slow in the US and they look to be at the early stage of the virus’ spread and most vulnerable to new bad news. We think only when the situation in the US is under control will market volatility start to fall. That said, we are not experts on epidemiology and this will be very hard to time. Knowing this we therefore bought a little when equities fell around -10% at the end of February. If equities continue to fall we will likely add a little more into our equity positions again where appropriate.
In terms of our broader performance, as you know we run risk controlled portfolios and use stress tests to make sure we stick within our internal risk bands. This is all precisely so we can ride out these sort of market events whilst leaving ourselves the room to exploit opportunities as and when we see them. So far, our portfolios are running in line with our internal risk models and are within our risk bands. Broadly, gains in fixed income are helping offset some of the losses in equity markets and our equity portfolio is, if anything, slightly out-performing our stress scenarios.
That said, we are longer term investors and are keeping our eyes on the longer term prize. This too shall pass. We remain committed to adding positions that we think will pay off over a longer term time horizon rather than trying to optimise for this week’s performance. This may mean a little extra volatility today but we hope and expect this approach will pay off over the longer run as it has done in the past. As ever, if you want to discuss this in more detail with us, feel free to get in touch.