The Investment Committee
21st May, 2020
The Three Legged Stool…
Equity markets have recovered some of their losses over the last month or so, with the benchmark UK equity market now down around 20% so far in 2020, after falling 35% from its January high to its lowest point in March. That 35% loss was the sharpest in market history, although, as the picture has become clearer, markets have bounced positively and are starting to consider whether a similarly sharp economic recovery is possible. They are still a long way off the levels seen at the start of the year however, so what are they deliberating over?
One key factor is the negative news cycle. The media do a fantastic job at painting a portrait of doom and gloom, and this of course trickles into investor behaviour. A second wave of the virus, which might lead to further lockdowns is the real risk here, and if that occurs then equity valuations are still too expensive, and are therefore likely to fall again from here. That possibility is something we are watching closely, although it is certainly not the only thing that matters.
A more supportive factor has been the Government and Central Bank stimulus, which we referred to in a recent blog as “life support” rather than traditional stimulus. Much more is on its way in the coming months from policymakers across the globe, and so whilst markets understand the virus’ threat, they also appreciate the financial antibody that is being injected to fight the recession.
Moreover, experience helps you to understand any situation, and in our analysis of previous recessions we have acknowledged that ‘this time it’s different’. More specifically, there is another key reason why markets may not fall to the -50% or -60% levels seen in some previous recessions. Unlike the dot-com bubble in the late 90s which centred around technology stocks, or the global financial crisis which centred around financials, this time around the sectors that make up a large portion of investment markets haven’t caused the problem, and are instead likely to offer solutions.
The US equity market is a great example of this, where technology and healthcare make up a combined 41% of the index, compared to financials and energy (which are generally the worst hit sectors in a recession) at just 13%. This is in stark contrast to the last recession in 2008, where energy and financials made up over 30% of the market. Healthcare and tech are certainly going to be key to getting us out of this mess and not drive us further into it.
For these reasons we believe we have a more resilient market environment than we have seen in previous recessions, providing us with optimism that there is huge opportunity, once the big questions are finally answered. Our portfolios are now down between 0.11% (Very Low Risk) and 2% (High Risk) over the last 12 months, versus the UK equity market which sits at -15%, placing us in an excellent position to take advantage when the time is right.
For now, markets can be viewed as a three-legged stool. Central bank support is one leg, government support another, and the virus’ trajectory the third. Markets require all three legs of the stool to be stable, and whilst two have been put in with superglue, the virus’ leg is there but isn’t attached as well as we’d like. The re-opening of economies without a second wave and progress on a vaccine are both needed to provide that further stability. However, irrespective, we think there are reasons to be cheerful, because as active managers we have the ability to reduce your exposure to the areas of most threat and commit more to those where the opportunity is clearer.