It’s been a tough time to be an investor over the last few weeks. Equity markets are down anything from 20% to 40%, depending on the market. Energy markets were even worse, down around 50% with WTI getting all the way down to around $20/bbl. It has been one of the most dramatic crashes of all time.
Given everything, we navigated relatively well through this crisis. Our clients and the portfolios we advise were underweight equities and, where we could, overweight US Treasury bonds. For certain long-only equity accounts we advise, we cut back in January and again in February, taking cash levels to over 30%.
We had tracked events in Wuhan since January, but had expected the outbreak to have been better contained, so didn’t feel it necessary to raise more cash at the time. Unfortunately, the West has done a terrible job of containment and we have raised further cash as appropriate.
During the quarter we have gone significantly overweight e-commerce plays and online gaming, as well as Healthcare. We have also added to our precious metals exposure. These areas have worked out relatively well, but as we have seen in prior market events like this, even great companies get sold down in the rush for liquidity.
Our thoughts on how things will evolve:
Its important to note that this is written as a best guess outlook based on publicly available research. I am not a virologist.
Certain countries, mainly those that have experience of MERS and SARS, are doing a much better job than the West as a whole. The US and UK are facing a terrible situation, as they are not imposing the necessary, social distancing and lockdowns. It will likely be even worse in the Southern Hemisphere which is approaching winter. While not a virologist, it would seem reasonable to assume there will be some similarities to the typical flu seasonality patterns.
We expect the number of covid-19 cases to increase significantly in Europe, UK and the US.
On current projections, we expect cases to reach a few hundred thousand in Europe and a similar number in the US. Given lockdowns starting to become effective, European number should peak around the first week of April while the US should be a week or so after. But only if countries really enforce social distancing and the like.
That unfortunately will not necessarily be the end of it though.
Unless the virus mutates or we have a vaccine quickly, there will be the need to drive herd immunity.
This means that, once we are through the initial wave in the Northern Hemisphere April, we will need to go through a slow process of increasing immunity across the population. This would be likely through a process of lockdowns and then normality and then lockdown, rinse repeat until the herd is immunised.
It’s critical during this process to ensure the hospital system can manage the outbreaks as they occur, to minimise the mortality rate. So, this means, while we may have some reprieve in the Northern hemisphere during the summer months, we may get a second wave later in the year. No different from the Spanish flu.
It could potentially be a very low slow, and unfortunately very disturbing time.
The financial markets:
In terms of pricing, we are not at recession levels yet. The sell-off has been sharp and dramatic but at the index level we are probably only half way there, to get to levels were one can go overweight.
This does not mean we can’t have significant bear market rallies, just like we saw in 1929-’32. My guess is we will find a temporary floor in the next few weeks, perhaps at lower levels yet as infection rates peak in the US. After that we may get a rally, as infection levels start to fall off in April.
My fear though is that, unless a vaccine is found and circulated quickly enough, we will need to start to price in a much longer period of negative growth as lockdowns are re-enforced. That will result in further weakness.
Even if a vaccine is found, there is significant damage to the financial system and it’s unlikely for us to see a V shaped recovery. But we have some ways to go to see how it plays out.
Our Asset Allocation is very conservative at this point:
USD: We have been positive on the USD for a long while and even more so now. The bulk of global debt is USD denominated. A significant portion of this debt raised was then invested in foreign FX. In the environment we find ourselves in, there will be a rush to buy USD to ensure liquidity and solvency. Turkey, another one we have spoken about for a while, has over USD400bn in USD debt. Expect a blow-up there soon.
We expect the USD to go much higher in a hurry and then very quickly, with significant FED actions, to weaken relative to others. Which is when Gold will really shine.
We have been overweight US Treasury debt, expecting it to be good a investment as yields collapse to zero. This happened far quicker than we expected, with the US 30yr yield collapsing to below 1%. We have closed most positions here.
At this point, we would only advocate taking exposure to very short duration, high quality sovereign debt, as a form of ‘cash’.
There are opportunities for the nimble to take exposure to sold down areas in corporate debt markets ,but at the time of writing we are not getting involved here…yet.
Equities have collapsed more rapidly than we could ever have imagined. As somebody who was writing about the novel virus as far back as January, I’m disappointed I didn’t cut equities more. I had expected the West to take much more assertive action preventing the spread of the virus.
We are overweight those areas that will benefit from whole regions/countries being in lockdown – e-commerce, gaming as well as Healthcare etc.
We are looking to continue to add to these areas, but are cognisant that everything gets sold down in a liquidity/insolvency squeeze. We are underweight Equities as an asset class and still see stock picking as paramount – particularly now. The US market is still expensive and has, given the on-coming recession to come, further downside.
This is an area that we see the most upside in. Our clients on average now have around 10% exposure to Gold and Silver and we are adding opportunistically.
As the current crisis deepens, cash will likely outperform and gold, like we saw in 2008, may come under a little pressure. Forced margin calls, liquidation etc. will cause the precious metal to be sold down, but far less so than other asset classes, other than cash.
Once we start to normalise, though, precious metals should really shine.
Silver has been sold down and provides the most opportunity here, but through a crisis, cash and gold are the best plays. We are also adding to the precious metals miners which have been massively sold down – this is an area only for the brave as the space can suffer significant drawdowns in a liquidity squeeze, like the one we are witnessing,
Why do we like precious metals?
At the moment, there is a huge sucking sound as the markets de-lever and ramp up USD holdings. There is also significant demand for USD in China, particularly given weaker exports. Once we get through this though, there will be enormous pressure on the Fed to weaken the dollar, as fiscal spending balloons and universal basic wage and MMT goes live. At that point, dollar strength will reverse in a hurry and the precious metals will rally aggressively.
While we have resisted taking exposure to bitcoin, we take the view that the current environment may offer good opportunities to take exposure here. We see BTC as an electronic version of gold, though one which is untested and has no history as a replacement for fiat currency. If BTC is perceived as a store of value by an increasing user base, it will increase significantly in value. The perception that it is a store of value is critical in this equation.
Once we can attest to the sheer scale of Fed actions and MMT, effectively free money for all, those asset classes considered a good ‘store of value’ are going to shine. We believe BTC will likely be one of those.
In these times of stress, we wish all our readers well. Self-isolate where you can and practise social distancing – we will get through this together if we each do our part. Keep washing those hands.