The global economy
From an economic perspective, the rapid spread of Covid-19 to all corners of the world has caused a sharp demand and supply shock to the global economy, and this will inevitably lead to a recession. In response to this, policymakers around the world have reacted quickly and decisively, using all the financial levers available. Interest rates have already been cut to near zero and central banks have returned to massive quantitative easing, but the main tools are now government spending and taxation. Measures range from straightforward tax relief to the effective underwriting of wages to private sector workers. Governments are essentially handing money to the public, and in the US this is a direct cash payment, known as “helicopter money” by monetary economists. Who would have expected that “unprecedented” would become an overused word.
As you will know, the markets have been swinging wildly from day to day. There have been record downswings, but also record upswings.
The sharp decline in the equity markets from mid February to mid March was extreme by any historic context. Investor sentiment fell rapidly, but markets were clearly affected by technical factors too, such as short selling and automated selling at trigger points. The UK market fell further than other markets during this period, partly because of the exposure to oil and gas, but also due to short selling, which is banned in other European countries such as France and Germany. As a result, the UK has faced greater selling pressure from global investors seeking to hedge European exposure to the virus.
In the last week, the technical selling pressures mentioned above seem to have receded. Investors have reduced risk in portfolios and the full extent of government and central bank support is now known. There is less volatility in the system and equity markets have rallied from the extreme lows.
Volatile and falling markets tend to encourage further selling behaviour, which may be a reasonable decision for a short term trader. However, the right approach for a long term portfolio investor is to run contrary to the herd. When equity markets fall, it is time to start moving cash out of other assets that will have performed better in the downturn (such as bonds) and invest into equities. At these levels, the future returns from equities are likely to be very high in the long term and will outperform other asset classes such as bonds, cash, and commodities. As the respected investor Howard Marks said recently, the equity market in general is essentially ‘on sale’.
In response to this ‘sale’ and, as detailed in previous correspondence, we have been actively adjusting client portfolios over the last few weeks. We have done this by buying equities which have fallen in value, and also by increasing the ‘strategic’ level of equity market exposure across all client mandates. These are meaningful changes and, from experience of previous market downswings, we know this is the right approach. The market may become cheaper still in the coming weeks and months, of course, and so we plan to continue upweighting equities gradually as time progresses.
Our investment strategy also considers the fact that, at times of extreme market falls, shares tend to be sold indiscriminately at first. Some businesses are more resilient than others and so won’t be impacted as much by the crisis. Shares in these companies don’t deserve to fall as far as others and this presents opportunities that we aim to take advantage of.
Where are we now?
We continue to track the numbers of Covid-19 cases in the major economies. In Asia, policies of containment in China and Korea have already reduced the case numbers to near zero, leading to an easing of restrictions and cautious reopening of economies. However, this involves a level of surveillance which is unlikely to suit western cultures. The Chinese authorities have the ability to harness technology and authoritarianism to monitor their population closely. Individuals are given red, amber or green status according to their risk level. Movements are tracked by mobile phone data and people’s temperature is taken regularly by officials.
Ultimately, the west is more likely to deal with the virus by striving for herd immunity rather than relying on social compliance or ‘big brother’ style monitoring. Therefore, over the next few months the numbers of casualties attributed to the virus will be far higher in Europe and the US than countries such as China and South Korea and Japan. However, this simply means that those countries will not achieve herd immunity as quickly and will risk ongoing flare-ups of the virus until a vaccine is developed and distributed.
When and how will it all end?
The ultimate duration and size of the impact of Covid-19 is unknowable, but it is unlikely to end completely until a vaccine is developed. In the meantime, scientists are racing to fill in the blanks, such as the extent of the infection among the untested population. An interesting case study is the town of Vo in Italy, which was placed in isolation and the whole population tested. Half of those who tested positive for Covid-19 showed little or no symptoms. If this statistic is valid for the wider global population then we may be further along the journey than currently perceived.
To restrict or not to restrict
In Sweden, the government seems to be taking a very different approach to the rest of Europe, seemingly suggesting that overreaction is more harmful than underreaction. Restaurants, schools, and gyms remain open. The statistical model the Swedish government is using predicts far fewer hospitalisations per 100,000 of the population than the UK model. The Swedish authorities assume there are already many infected people without symptoms, although there has been no structured testing. Underestimating hospital surge requirements could be devastating for the country. The opposite viewpoint, as mentioned above, is that countries with fewer restrictions will reach herd immunity faster, and dramatically reduce the risk of further waves of the epidemic. In addition, it is argued that the longer term impacts of economic hardship may ultimately cause more deaths than the epidemic itself.
In the US, President Trump is keen for a return to work as soon as possible, but there is wide difference of opinion from state to state. So far, New York has been the hardest hit. Policymakers may decide that the need to preserve human life does not entirely negate the need to preserve economic activity. Given that the healthcare safety net is too costly for vast quantities of Americans, and workers lose their health insurance when they lose their job, it is likely that the US will ultimately be the hardest hit.
Whatever the approach, millions around the world are experiencing various degrees of restriction and confinement, and the coming weeks and months will be a test in terms of social compliance.
There are three main elements that will move the world faster toward recovery:
In the short term, the sooner an accurate, cost-effective test for antibodies can be created and distributed, the faster those people who test positive can return to work. Clearly this will require strict oversight to ensure people don’t fall through the net.
2. Better treatments and therapeutic drugs
There is also a race to determine the best way to treat those most at risk. The World Health Organisation announced an international trial on 20th March, with four different drugs being tested; Remdsivir, Chloroquine, Kaletra, and Kaletra plus interferon beta. These are the drugs that hold the most promise. Patients are being recruited around the world, who will be randomly assigned one of the four drugs. Data will be monitored by an independent board, and the trial is adaptive, meaning it will evolve as results come in. Ineffective drugs will be dropped and replaced by more effective ones. This is clearly not how clinical trials normally work (for example, there will be no placebo), but it will allow the best potential treatments to be compared quickly.
3. A vaccine
It will likely take at least 12 months to create, properly test, and then produce enough vaccine to deliver to all the corners of the world.
The market swings experienced over the last few weeks are likely to continue at least until Covid-19 case numbers show signs of stabilising in the major economies of the world. Then the focus is likely to turn from the present crisis toward the order in which different parts of the global economy will start to recover, and to the likely pace of the return to normalisation. Developments in the three ‘game-changers’ above (testing, therapeutic drugs, and a vaccine) will also help turn the tide of sentiment.
In this rapidly evolving and volatile market, we continue to stick to our investment philosophy. It is more important than ever to invest with a long term horizon, incrementally upweighting equities at these lower market levels, while taking opportunities to acquire quality companies that have been impacted by the short-term uncertainties resulting from the Covid-19 pandemic.