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What's Going On?

Let's make sense of this crazy world, together.

The C Word 🦠

It's been an eventful two weeks since you last heard from us. So today, we want to spend some time taking a closer look at what's been going on in the financial markets, and what COVID-19 - otherwise known as coronavirus - means for your investment decision making. 

Setting the scene

Before we begin, however, it's worth spending some time looking at where we were before the market meltdown started. To put it simply, the first two months of 2020 saw a strong rally in risky assets (e.g. global stocks, commodities) as well as a strong rally in safe haven assets (e.g. US treasuries, Japanese Yen, gold). Having both risky and safe haven assets rising in value at the same time isn't a situation which you can sustain indefinitely - at any given point in time we are either in a relatively low-risk (i.e. strong demand for risky assets) or high-risk (i.e. strong demand for "safe" assets) environment - something had to give. And boy, did it give...

Where are we now?

The stock market moves in the past 2 weeks since the sell-off began have been nothing short of spectacular: S&P500 -11%; FTSE100 -13%; EUROSTOXX50 -15%; NIKKEI -11% - you get the idea. 

In other words - there has been a marked shift towards - and increased demand for - safe haven assets: US Treasuries have rallied to offer historically low yields on 10-year and 30-year bonds, the Japanese Yen has gained c. 5% versus the US dollar and demand for Gold has been robust.

In response to these moves, central banks from G7 economies have discussed the potential for coordinated monetary policy action. Even more unusually, the US Federal Reserve carried out its first emergency rate cut since the global financial crisis in 2008 to cut interest rates by 0.5%. And there's talk of potential fiscal policy measures (i.e. government spending) to offset the economic damage that might be inflicted by the coronavirus (more on this later). But let's just take a minute to step back and assess the situation.

WTF is actually going on?

Let's start by identifying the 3 main dynamics at play here: 

  • Dynamic 1: The human cost / expected loss of life
    • This stuff is pretty morbid to think about so apologies in advance, but it's something which needs to be discussed. While we can't be sure how many lives the coronavirus will claim before it's all over, we don't think the actual number of fatalities is likely to have a long term impact as far as the global economy is concerned.
  • Dynamic 2: Fear-driven impact on the real world and businesses
    • This is a big one for the global economy. Given the widespread nature of this pandemic, people are changing the way they normally go about doing things - from corporate travel bans to postponed public events to working from home. These things all obviously create friction in the way the world operates on a day-to-day basis, causing businesses to sell less and be less productive overall. It's likely that this "new normal" will persist for at least the next 3 months - until the northern hemisphere reaches summer (at which point the virus should find it more difficult to keep going). 
    • This dynamic should hurt some businesses more than others. For example, airlines have seen the biggest share price drop (around 30%) since it all kicked off, with some nearing the brink of going bust and one (Flybe) already having gone under. Elsewhere, businesses with high levels of debt relative to their ability to pay interest on that debt could be in real trouble if they start defaulting on their debt. This is an important dynamic worth monitoring as it could spark a more widespread corporate credit crisis, and that really would mean long-term trouble for financial markets. These worries have also been reflected in the stock market moves, with highly indebted businesses seeing the biggest share price declines relative to their cash-rich or income-rich peers.
  • Dynamic 3: Monetary & Fiscal policy responses
    • As mentioned earlier, the US Federal Reserve made an aggressive decision to cut interest rates by 0.5% in order to ease potential tensions. But what actually happened? Well, it gave investors some confidence...for a grand total of around 24 hours, before things went south again. This is primarily because while monetary policy is a very effective tool at managing any liquidity issues in financial markets (credit & financial crises for example), it isn't very effective when it comes to dealing with pandemics. This is a real world problem which needs real world solutions, and while medical professionals get a vaccine ready, the only meaningful real world solution we have is fiscal policy...
    • Which explains why there has been growing focus and pressure on governments to announce spending packages to help cushion the blow on the global economy. The US Congress signed off on a $8.3bn spending plan to slow the spread of the virus and there is increasing pressure on other governments in Europe and Asia to start spending, too. Watch out for any signs of a fiscal package from Germany, the UK and/or the rest of Europe. This is likely to boost markets more than monetary policy decisions.

Ok that was a lot to digest, but where do we go from here?

This is the billion (trillion?) dollar question. While there's clearly a full blown global healthcare crisis on our hands, we aren't convinced that it's a long term economic crisis...yet. It all depends on exactly how big this pandemic ends up being, which is anyone's guess.

In the absence of a crystal ball (+ an understanding of the latest mathematical models which analyse this pandemic) to see how this plays out, we think it makes sense to look at previous market corrections to see where we might end up. 

Looking at recent global financial market corrections (Oct-Dec 2018, Jan-Mar 2018, Jan-Feb 2016) and using the S&P500 as a barometer, we have seen declines of around 15-20% each time. This market correction is slightly different, however, given none of the previous ones were driven by fears of a pandemic. Another point of reference could be the global financial crisis, which saw a roughly 40% decline in the S&P500. 

With the S&P500 currently c.11% below its recent peak, we think things could get slightly worse before they get better again from an investment perspective. Given the nature of this correction, we think this could provide some interesting investment opportunities over the next few months - assuming the pandemic doesn't snowball into something truly catastrophic.

We want to end this one on a slightly sombre note. It's fine to think about finance and how you might either protect yourself against a worst-case scenario, or invest in a potential recovery, but at times like these we feel that it's vital to take a moment to appreciate the most valuable assets in life: your health and those you love. We encourage you to go and do just that. Right now.

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What Else is Going On?
Sector Impact

As mentioned above, this pandemic is wreaking havoc on financial markets. We wanted to spend some time looking at what's going on with individual sectors, so we've listed the sector performance (using the S&P500 as a barometer for global sector moves) below for you with a quick bit of insight to make sense of it all.

S&P500 Sectors Year-to-Date Performance:

Energy -31%, Materials -15%, Industrials -13%, Consumer Discretionary -10%, Communication Services -9%

  • These are your classic "cyclical" sectors which do well when the global economy is going strong, and suffer when it slows down - the fact that these are worst performing sectors shouldn't be a surprise

    Financials -19%

    • Banks are struggling due to the double whammy of being a cyclical sector like those above, as well as a lower interest rate environment which will likely reduce their ability to charge healthy interest rates on loans they provide

    Healthcare -7%, Consumer Staples -5%

    • These are the "defensive" sectors - regardless of what is happening in the global economy, people will need access to food & medicine. During times of market distress, these sectors tend to perform "relatively" well

    Information Technology -6%

    • This sector's performance is mostly driven by your everyday favourites of the tech-giant variety, which have held up relatively well 

    Real Estate -4%

    • The Real Estate sector is another "defensive" one which typically does relatively well during market sell-offs. And this time it has been further boosted by the US Fed's 0.5% rate cut decision, which should over time reduce borrowing costs for those looking to purchase real estate assets

    Utilities 0%

    • This is probably the most defensive sector there is - in almost every scenario, we need our homes to remain heated, potable water flowing out of our taps and lights switched on when dark outside. Again, unsurprising that Utilities as a sector has mostly sidestepped the market sell-off
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