Capital Markets Update
- In a nutshell
- COVID-19 Chaos
- Governments and central banks fight back
- Brent takes a bashing
- Assessing the damage
In a nutshell
Risk assets plunged in March as markets rapidly priced in an economic slowdown caused by the COVID-19 pandemic. On a regional basis, (in GBP terms), all major regional equity indexes posted sharply negative returns. Japanese equities held up best, owing largely to the safe-haven Yen strengthening in this time of market stress. UK equities lagged, due to their higher exposure to cyclical sectors, in particular energy which collapsed due to a new oil price war. Yields continue to fall as investors fled to safe-haven government bonds, compounded by the expectation of future central bank interventions.
This strain of coronavirus showed no mercy in March, penetrating every major global economy, with total infection cases nearing the one million mark. Across the world, governments imposed more and more stringent restrictions on workplaces, social gatherings and transport. Policymakers hope that these measures will help to ‘flatten the curve’ and spread out over time the impact on their healthcare systems. There is evidence that this strategy has worked successfully in China and South Korea, which is encouraging to see. However, the central engine of the global economy, the United States, is unlikely to see a peak in infections anytime soon. In addition, there remains uncertainty over the length of time that countries will need to remain in lockdown.
Governments and central banks fight back
Thankfully, policymakers have not sat idly as the chaos has unfolded, with unpreceded fiscal and monetary stimulus being unleashed. In the US, Congress passed a $2 trillion stimulus package, bigger than the 2008, 2009 and 2011 packages combined. This includes loans and tax cuts for corporates, as well as direct cash payments and expanded unemployment insurance for individuals. Governments across the world have been rolling out similar measures, in an effort to cushion the economic impact of both the demand and supply shocks. On the monetary side, the Federal Reserve has pumped more than $3 trillion in loans and asset purchases to try to shore up market liquidity and ease financial conditions. Similar measures have been implemented by central bankers globally.
Brent takes a bashing
Global markets also got hit on a new front by a major oil supply shock. On the 8th March, Saudi Arabia announced huge discounts on the price of its oil exports, triggering a free fall in oil prices. Brent Crude dropped 30%, the largest fall since the Gulf War. The move was triggered by a breakdown in talks between OPEC and Russia on the size of future oil supply cuts. Whilst the fall in the oil price should be good for consumers, many oil-exporting economies have been very hard hit. In addition, energy sectors across the world are looking increasingly distressed, facing both demand and now supply problems. For many producers, the current oil price is well below their break-even level. For energy sectors to recover, there will need to be improved coordination between OPEC and non-OPEC members on supply, but also an improvement in the demand outlook.
Assessing the damage
Given the continued uncertainty around the future direction of COVID-19, it is impossible to gain an accurate picture on what the full economic impact of this will be. What is without doubt now is that the global economy is going through a deep recession, and we can see evidence in some of the data already, with unemployment claims soaring and business surveys pointing to slowdown. The question for investors then is on the nature of this recession, will it be a quick bounce back (“V shaped”), a slower recovery (“U shaped”), or something altogether more sinister (“L shaped”)? The answer to this will depend on how effective health, fiscal and monetary policy will prove to be.
Multi manager team views
Whilst we cannot claim to have foresight on how events will escalate from here, we are encouraged that China and South Korea appear to have made significant progress with flattening the infection curve, and there are already tentative signs of their economies getting back to work. However, the US and Europe were slower to implement containment policies, and theirs have been less aggressive than China and so it is unlikely that they will be able to replicate their success. We would be extremely concerned about the possibility of an ‘L shaped’ recovery, in which future output is permanently impaired, if it were not for the significant global policy response. Governments and central banks have thrown the proverbial kitchen sink at this problem, to do everything they can to soften the blow, which makes us think that this will at worst be more of a ‘U shaped’ recovery. The possibility of an early vaccine could even make it a quick ‘V shaped’ recovery, but this looks very unlikely.
Given the current uncertainty over both the future direction of the virus and the economic fallout, we believe an element of caution is still warranted on markets at this juncture. In February we de-risked some of the portfolios in anticipation of further pain. In March we reduced some of our smaller more illiquid cyclical holdings, whilst tactically adding to higher conviction quality managers on the falls. We have been engaging with our fund managers extensively during this period to better understand the risks and opportunities going forwards and stand ready to take advantage of future volatility.
Periods of market stress like this highlight the importance of maintaining a diversified investment portfolio, which is at the core of our Octopus proposition.
The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation.