March market update – The impact of coronavirus…

Coronavirus fears spark steep falls in riskier assets

A solid start to the year was brought to a juddering halt in the last week of February as investors sharply reassessed the risks posed by the spread of the coronavirus. As news of outbreaks in Italy and Iran began to sink in, the belated acknowledgement that this really was a global rather than a local issue, prompted a swift and aggressive re-pricing of all assets around the world. Riskier equity, commodity and credit markets fell sharply as exposures were reduced, and cash was either parked or redeployed into safer assets such as government bonds or gold. By the end of last week, the year to date returns of the UK stock market was around the -12% mark. Gold was up +9.5% and UK government bonds around +4.8%. From an investment perspective, the arrival of coronavirus was particularly unfortunate timing. Last year was a sluggish one for economic growth, prompting some hefty intervention from the world’s central banks who quickly and aggressively reversed policy in an effort to head off a possible global recession.

The resulting wave of cheaper money that entered the financial system pushed asset prices up to record levels in anticipation of an economic acceleration in 2020. There were tentative signs of this happening – hence the solid start to the year – until the viral outbreak arrived to put a very large dent in those aspirations.

“As we write, analysts, traders and investors are trying to work out the correct prices for assets”

As we write, analysts, traders and investors are trying to work out the correct prices for assets in a world where, for example, the Chinese economy has just been jolted from a +6% growth rate to -4% contraction for the first quarter (according to JP Morgan). Assessing the impact of such a shock is never easy and it becomes even more complicated when the rest of the world is at such an early stage in dealing with the epidemic. Faced with such a cloudy outlook and beginning from a record high starting point, it’s no surprise that optimism has evaporated and risk assets have fallen so quickly.

What can we say with reasonable certainty?

Using history as a guide, the sharp falls of last week would imply something like a 40% chance of a global recession in the current year, which is quite a reversal in only two short months and puts the pressure firmly on governments and central banks for some form of response. The most likely offsetting actions include more interest rate cuts (-0.6% priced into the US interest rate market for example) and no doubt, an innovative suite of fiscal measures too. The Hong Kong government has, for example, earmarked $9bn for cash handouts to adult residents, as well as payroll tax cuts in response to the economic slowdown brought about by the coronavirus.

“The most likely offsetting actions include more interest rate cuts and no doubt, an innovative suite of fiscal measures too”

We can’t hope for as much in the forthcoming UK budget (!) but we wouldn’t be surprised if this sort of response becomes a feature elsewhere if conditions deteriorate. In the short run these actions won’t really do anything at all to move quarantined workers back into production, only a peak in infection rates will do that, but they should at least ensure that the financial system is awash with liquidity, which tends to sooth investor nerves. Looking into the medium term, it’s unlikely that we will see any drop in volatility until either the major economies have also seen a peak in infection rates (still some way away) or investor positions have become extremely bearish. We aren’t there yet on either measure and, as a result, we don’t think we can view last week’s moves as a true buying opportunity.

The section below will outline in a little more detail how portfolios have actually been doing so far this year, but it is broadly fair to say that the vast majority of mandates are in good shape. This is generally because our starting point coming into the year was to maintain a very broadly diversified set of investments (not just equities) and an open-minded approach to adding or subtracting risk depending on the data available. This positioning allows us to monitor developments patiently and wait for opportunities to appear, as opposed to retrospectively trying to fix things in a hurry.

“It is broadly fair to say that the vast majority of mandates are in good shape.”

More specifically we are keeping an eye on real world activity indicators such as shipping rates or the prices of industrial metals, which are showing some signs of stabilizing in tandem with Chinese activity, now slowly picking up again as the rate of new local infections stabilizes. In addition, we use external research providers (from JPMorgan, Societe Generale to name but two) to monitor investor positioning to alert us to changes in trading patterns, as well as shifts in expectations or sentiment. We doubt there will be much portfolio activity over the next few weeks, outside of a few opportunistic trading decisions, but there is undoubtedly a rapidly lengthening shopping list for the moment when we move from a potential buying opportunity into a real one.

Portfolio performance

Overall portfolios have returned between -2.0% to -5.1% in February in the context of local stock market falls of  -9%. That brings year to date performance in the range of -2.1% to -4.6% in the context of -12% local stock market falls. Unsurprisingly it was equity managers who were the weakest performers, with little difference between the regions. Gold and bond managers were the centres of outperformance with a notable mention going to some relatively new positions in convertible bonds via Lazard Rathmore and Aviva, both of which have managed to deliver a positive return in a difficult month.

On behalf of the Saltus Investment Committee, March 2020

Saltus Asset Management Ltd is authorised and regulated by the financial conduct authority. Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested.