Last night, we watched on as our new chancellor announced an unprecedented fiscal policy bail out to companies and citizens across the UK to the tune of £330bn, with the promise of more support if needed. In his opening statement, he declared “We will support jobs, we will support income, we will support businesses and we will help protect your loved ones, we will do whatever it takes”. Later the same day, we observed Steve Mnuchin announcing another tranche of US support to its citizens amounting to $1.2 Trillion as he stood alongside President Trump, stating that more support is needed as the US is faced with the threat of 20% of its workforce becoming unemployed in the coming months. To provide context to this statement, US unemployment reached 10% in 2009 amid the global financial crisis, and 24.9% in 1933 at the depth of the great depression, illustrating the magnitude of concern within the US administration on coronavirus-related economic disruption.
In response to the rapidly escalating coronavirus situation in the US, Deutsche Bank announced earlier today that they are expecting the largest ever GDP decline in the US and ING have said a recession in the US is unavoidable. These truly are unprecedented times, and government actions are now matching the concerns.
Against a backdrop of fear and uncertainty over the extent of the damage on the global economy, we are happy to be heavily positioned in cash, watching from the side-lines as this story plays out. In the coming weeks we are not expecting a rapid reappreciation of equity valuations, and recent actions from governments and central banks around the globe reinforce that we are still very much at the beginning of this story, with significant concern about where it leaves consumers and corporates. According to many economists, as a result of efforts to avoid one humanitarian disaster, we are now heading into a global recession that is man-made and unlike anything we have ever known.
At the moment, all we know is that the global economy is shutting down and this has never happened before at current levels of global economic integration. We are likely to have this shutdown in place for the coming three to six weeks, so we are looking at some form of normality starting to resume at the end of April, early May if we are lucky. As a result, the Global economy is expected to be extremely fragile, and no one knows how bad it will get, which is why governments around the world are doing everything they can to help stimulate activity. All governments know at this stage is there are going to mass layoffs and redundancies, with reduced spending on anything but essential items while we are in lockdown. In the UK, we need to make sure the gap between being laid off and getting benefits is reduced to nil and provide help for everyone, irrespective of the cost. If we do not do this, the humanitarian consequences of trying to avoid one problem will become greater than the problems we were trying to prevent.
In the US, the government is attempting to give $1,000 in cash to all Americans that qualify on April 1st and then more in May if things do not improve so they have money to feed themselves! The key strategy for all central governments now that global interest rates in many developed nations is virtually at Zero or negative, is to provide as much support, assistance and money to get people through the next six to twelve weeks. If they do and we maintain some form of functioning financial system and employment remains high, when we start functioning normally again as a society with free movement of people and goods, then we may stave off a depression, but at this juncture, no one knows and no forecasts are of any use as this has not happened before. As it stands:
- When the VIX (measure of market volatility) is above 30, risks are high and moves are unpredictable. The chart below shows the current index reading:-
- The fact that the VIX has closed above 80 for only the third time in history is deeply concerning. The other two instances were during the global financial crisis in the fourth quarter of 2008. It’s becoming apparent that we’re in the depths of a COVID-19 financial crisis of 2020, with much left to be written. What comes next is nearly impossible to predict, but escalating fiscal injections and a commercial paper funding facility look to be the probable policy steps. These are measures designed to help banks and money flows and stop a financial crisis developing. As it stands, we have falling oil prices, a declining gold price, a high VIX reading and increasing credit spreads on corporate debt all happening at the same time. The last time this happened was in 2008, and the signs are ominous.
- Looking at stocks and shares in the last two recessions, these assets lost more than half of their initial value when looking at peak to trough. The last three recessions in the US saw price/earnings multiples drop to 10.1x, 13.8x and 10,2x. With current P/E ratios at circa 15x there could be more room for equities to fall further. This is even more likely on the basis that many companies are making forecasts with no clue as to how much their income is going to fall, and therefore they have no idea how much the earnings are also going to fall. If equities are expensive based on today’s earnings forecasts, imagine how expensive they are if earnings are downgraded significantly from here.
- If we look across different asset classes over the last month, there has been nowhere to hide. Even gold is now declining in value, and with credit risks rising, even low risk investment grade corporate debt that is also falling in value. No one knows how many dominoes will fall before we see a bottom, therefore until we have some clarity or perspective on the depth of the slowdown, we view this market as being uninvestable.
- In times like this, the safest asset for UK investors is typically UK Government debt, however the price swings on this asset have been abnormally large. Should market conditions continue to deteriorate and cash becomes a risk, we will have to invest in UK government debt to protect capital, however at the moment this asset carries significant price volatility. As it stands, in the last month if you had bought that at the wrong point, you would have lost over 6% due to risk of default and creditworthiness of nations being undermined. Overall there are very few assets I am rushing to buy at the moment.
On a brighter note, there is no doubt that central governments are doing all they can, and the central banks are keeping liquidity flowing, so at the moment banks appear to be sound financial institutions. We are watching this point very closely however, and have the situation under review should bank health rapidly deteriorate.
The UK has already announced loans, mortgage support and rate relief for everyone in the hospitality and retail sector, alongside loans to any business to help sustain them through this. We are expecting further support for those renting and for more to be done if we start to see hardship being experienced. As we move through this, we need to be strong, supportive of each other and watch out for our neighbours and friends and keep communication open to our parents and loved ones so no one in society feels isolated.
Overall, we will get through this and the world will not grind to a permanent stop. At the end of the day, we will start free movement and spending again, and the global economy will start functioning again. When that happens at this point will be an almighty sending splurge, society will change, corporates will hold more stock and we will hopefully have a great deal of compassion for those who have suffered and quickly rebuild. Despite this hugely uncertain and worrying situation, we will sleep safely in a defensive position, accepting that we are looking at ways of diluting our bank risk and assessing what to do if the situation gets worse. Today banks are strong, and we are safely at shore watching this nightmare unfold.
For more information on our thoughts on the longer term impact of the outbreak on growth, please see the attached Market Update document.
Key Event We Are Watching This Week:
- Tuesday: Eurozone, UK, US PMI data for March
For anyone who wants further data to substantiate the position please review the attached Global Economic Update document and the Economic Dataset below.
Model Portfolios & Indices
Global stock markets experienced a sharp sell-off over the week due to fears over the COVID-19 outbreak in key economies around the world. Following our defensive moves in recent days and weeks, we have not moved anywhere near as negatively as the indices, however the portfolios declined over the week, with higher risk portfolios being more exposed to equity market movements. After an increase in cases around the world and new lock down measures in an attempt to contain the virus, we now see further risks ahead and expect to see a further decline from here in the near term as consumer spending and demand continues to be effected. The recent drop in portfolios and indices is hugely disappointing, however we are now defensively positioned amid rising downside risks, and remain optimistic about a growth pickup in the second half of the year, allowing us to regain lost ground.
Please note that the YTD data in the table below reflects performance from the start of the new year.
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the day’s movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested.
Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 1965, Cosmonaut Alexey Leonov became the first person to walk in space, leaving his spacecraft Voskhod 2 for 12 minutes. This marked an important event in the Soviet Union’s space race with the US, with the US completing the task just 3 months later.
Have a great week,
Jason & Gina