Coronavirus Report from our Investment Director
The coronavirus has caused significant disruption to financial markets around the world. Richard Urwin, Investment Director at Chesterton House, explains the market reaction and how we are protecting our clients’ portfolios.
The coronavirus and national attempts to slow its spread are causing serious economic impacts. Stock markets have fallen, and whilst most long-term investors will sit tight and wait for recovery, some investors will choose to sell, causing stock prices to be marked down. For every sale transaction there has to be a buyer on the other side, and investors are naturally reluctant to buy without a significant discount when our collective view of the future turns bleak. In this environment no-one would be blamed for being worried about the long-term safety of their invested funds.
I’ve lived through these types of markets before and we are seeing a pattern emerge that is typical of these conditions. After the sustained rise in market values we have experienced since 2009, we are seeing that when things start to turn the reaction tends to be fast moving, prompting more investors to sell and resulting in the extreme levels of volatility that we have seen in markets over the last two weeks. Markets tend to overshoot in the short term as selling fever takes hold, but after this knee-jerk reaction investors begin to make a more measured assessment of market valuations, and eventually this type of herd-driven mentality comes to an end.
I do not wish to play down the effect on growth that is likely to be experienced as a result of this shock to our economic system, and there will be business failures as a result of the efforts to slow the spread of coronavirus with airlines and hotel groups particularly at risk, especially those with weak balance sheets and lots of debt. However it is also the case that many sectors will suffer much more mild effects and some will even benefit from the crisis (toilet roll manufacturers to name but one!). The vast majority of businesses will still be around as things recover, as with most recessions.
At present things are evolving rapidly and central banks and politicians are taking very significant action to stimulate or support economic activity. The government has introduced draconian measures as it expects the peak in the number of people infected in the UK to be reached in 10-14 weeks’ time. It also expects that this virus may be around for a year or more.
Before the current outbreak I’m not sure many people were familiar with the word coronavirus, but it isn’t a new word with four existing coronaviruses circulating in the global population already. Although there are as yet no vaccines for any of them, there is currently a huge effort underway to develop a vaccine for CoV 19.
Most vaccines take up to a decade to get through the various stages and trials necessary to prove efficacy and safety. There is work on new RNA and DNA based vaccines and various steps to speed things up but the common view amongst scientists seems to be that to produce a reliable vaccine within 12 months would be a real achievement. This means that the virus will be with us for months at least and it is simply not viable for everyone to stay at home from now until then. Our national economy may be able to withstand such an extended spell of inactivity, but our own individual economies will not. We all need to be able to earn to live, and sitting at home will not be a viable option for the majority.
Expect Unexpected Good News
Investment markets tend to move rapidly in response to unexpected news. The coronavirus has seemingly come out of nowhere (or strictly speaking a livestock market in Wuhan, China) and taken investors by surprise. However this works both ways, and at some point news will emerge which will be just as unexpected as the news of the first few cases, the connected fatalities, and the toilet roll shortages. The World Health Organisation has been reporting falling numbers of new cases in China for some time, and in the last few days the number has dropped into single figures for new internally spread cases.
Finding the Bottom of the Market
"How Low Can Stocks Go?" was the headline to the Wall Street Journal's Money and Investing section on March 9th, 2009.
It wasn't an idle question. The Dow was on its fourth straight week of losses, while the broader S&P 500 index was below 700 for the first time in 13 years. Goldman Sachs put out a research report that warned the S&P could fall as low as 400.
In reality March 9th 2009 turned out to be the bottom of a several-month long financial panic that wiped away trillions of dollars in assets. But on the day of what now appears to have been the best buying opportunity of a generation, many only wondered how much lower the markets would tumble.
In fact they recovered sharply once it became clear that the world as we know it would not end and that businesses and the economy would recover. The ‘up’ days in markets can be quite sharp, and they can be quite unexpected when they occur. March 2009 was the bottom of the bear market in stocks in the Global Financial Crisis (GFC) but this was also probably the nadir for the level of negativity about the future. The two things are connected of course.
Impact on UK Growth
Market movements are often over reactions driven by fear and greed. The UK economy shrank in 2009 and it was one of the deepest recessions for some time. However, the graph below which shows UK GDP from 2000 to 2019 puts the GFC in perspective in terms of its economic impact. Whilst dramatic at the time, the crisis had a muted effect on long term growth, and our economy has continued to prosper.
Recession followed by Growth
I think it is quite likely that we will see a recession as a result of the coronavirus. However, once the virus runs its course or is headed off by the development of a vaccine we will see a resumption of economic growth. As long as the assets you hold have not failed then prices will recover. So let’s look at the resilience of the holdings in our core Chesterton House Medium Risk portfolio.
For a while our Investment Committee have been debating the duration of the current bull market and its possible demise. Before the spread of coronavirus our view was that prices could correct in some areas of global equities simply due to over valuation, but that the most likely candidate to bring the rise in stock prices to an end might be inflation and rising interest rates after a period of growth above trend. Of course, the bull market has now ended dramatically with the UK stock market off around 30%, and the cause is a previously unknown disease.
Investing in Uncorrelated Assets
In an effort to protect portfolios against these overvaluations in equities we had already been including assets in our portfolios which we consider to be lacking in sensitivity to the economic cycle. These include investments in infrastructure, renewable energy, residential care homes, social housing, student accommodation and debt secured against property. Many of these investments are held in the form of investment trust shares, the value of which can fluctuate separately from the values of the assets that they contain.
These investments are not generally affected by falls in retail sales or a contraction in the economy. They all produce most of their return in the form of income, so these investment trusts have good dividend yields.
At times like these, investors take a short-term view and selling can be indiscriminate. As a result we have seen the share prices of most of these trusts decline, albeit by far less than equities generally. There is no logic for this, but it happens at times like these as some investors sell ‘safe haven’ assets to raise cash as their equity holdings are so depressed. The net asset values of these trusts have not fallen but discounts have opened up between the share price they are traded for and the net asset value per share. This will correct in time as share prices come back nearer to the true value of the assets in these investment trusts. In the meantime these larger discounts to net asset value present buying opportunities for investors following a strategic plan.
Need for Financial Planning
The financial planning that we do with clients is designed to ensure we have catered for shorter term cashflow requirements either by setting aside cash or by funding income from the natural income yield of the portfolio. This means that the longer-term investments can be treated as such. There is no need to sell and the best course of action is to re-balance as usual and ride out what is likely to be a relatively short-lived period of volatility.
We should remember that for the vast majority of people who contract coronavirus 2019 it will be a mild illness. There are huge steps being taken by governments and central banks to shore up the financial system and cushion the economic impact. When recovery comes it will be swift in markets and is likely to precede the economic uplift. Like the recent falls, no one can predict with any certainty when prices will start to rise, but when they do you need to be fully invested to benefit.
We have been helping our clients to achieve their investment goals for three decades. If you would like help with your own strategic plan, contact us for an initial chat.