Investing and Covid-19

Financial markets fully reflect the current and future uncertainty that society is facing.
While this is first and foremost a humanitarian tragedy, it is having daily and dramatic impacts on markets, and will leave a lasting footprint on our global economy.
We see violent swings in stock markets on a daily basis. Circuit breakers (which suspend trading for a period) are triggered regularly and the idea of closing markets for more sustained periods has been mooted. Robust monetary and fiscal measures aimed at restoring confidence are having little sustained impact. There may be greater success with full on globally coordinated and clearly communicated measures. The IMF notes that while quarantining and social distancing is the right prescription to fight the virus, a healthier global economy requires the opposite policy action – constant contact and close coordination.

What has been the investor experience?
We have seen historic falls in stock markets. From its high in February, the US S&P 500 is down (at time of writing) by about 30%. To give this some context, since WW2 in S&P bear markets, the maximum drawdown has been 34.5% on average wiping out 65 months of prior gains.
Selling is broadly indiscriminate, but with front line sectors such as airlines, consumer discretionary, hospitality, etc. bearing the brunt. Geographically it’s red ink everywhere but Europe has been getting hit the most, reflecting it’s COVID 19 experience. Sectors like healthcare and technology have to date been performing better though still substantially down. Volatility remains extreme and this argues against taking any dramatic portfolio action on a day to day basis.
As for “safe havens” like bonds or Gold, performance is mixed. Gold went nowhere for about 5 years until 2019 when it began to perform and has been reasonable in the current crisis though it has given up a lot of ground since late February. This may be because there is a “dash for cash” from investors generally, or that Gold may be a crowded trade, as recent falls have been significant.
Government bonds had held up well. Lower rates and bond buying are clear positives and these low rates are here for some time. But even here the prospect of ballooning government deficits has weighed against the asset class in recent weeks.
And there has been some stress in the Corporate Bond market, principally in the US. Even within “investment grade” bonds, we have seen a deterioration in quality as many US companies had seized the opportunity to load up on cheap debt. Looking at both the blow out in the yields, as well as the costs of insuring against default, we are likely to see some company failures as result of drastic trading conditions over the next three/six months. An oil price that has declined by 50% in the last 12 months is a further hit to Energy companies, who have been to the forefront in raising capital.

Many people see the impact of these overall asset moves most directly in their pensions or investment savings. Of course, not all pension funds are the same and indeed the mix of a typical fund has changed significantly in recent years, with greater exposure to so-called “alternative” assets. Based on the average asset mix for standard pension funds here in Ireland, stocks are still the largest single investment category at over 60%. Stocks are an excellent long term asset class for achieving growth, but in the short term, can have a negative impact.
So far this year, the average pension managed fund in Ireland has lost about 20% in value.

What can investors expect?
We are in an economic recession. The only question is how long and how deep.
We are going to see a wave of downgrades to economic growth, domestically and globally, as forecasters refresh their numbers.
There will soon be massive downgrades to company profit forecasts, with, critically, almost zero confidence in those new forecasts, until there is greater visibility in the profile of the virus.
We will see downgrades and defaults in company debt and not all companies will make it through.
Volatility is likely to continue.
We should expect to see some fund closures or suspensions, as illiquid assets can’t be sold in the face of redemptions. We have seen this in some funds in the UK already.
All in all a very difficult background for investors.

What should investors do?
Firstly, some of this bad news is already reflected in the seismic moves we have seen already.
But we are likely to see further tough days. Reassuringly, policy priorities from governments are appropriate – get as much resources (human and financial) into our health systems, intervene and alleviate cash flow problems for individuals and companies, ensure that the “financial plumbing” (access to credit) doesn’t gum up. Government deficits will widen dramatically – as they should.

Investors need to stay truly diversified in terms of risk. In times of financial stress, assets don’t always perform as history dictates, and what may appear as a safe haven may not perform like one. Assets that should be uncorrelated may move together. And importantly what may look like a liquid asset or fund may not turn out to be so. At times like this it is important to examine an investment portfolio under these headings of risk, correlation and liquidity.

Advice is important but investors should also be careful in the advice they listen to. This is a crisis unlike any others in recent times for financial markets and indeed society overall. Normal metrics of what constitutes cheap or dear, opportunity or threat may not apply. Rather than price to book or price to earnings , net new cases may be a more important metric to focus on. Reacting dramatically to siren calls from commentators or analysts about whether to buy or sell is not appropriate. It is a time to be measured in response and action, and not to overreact.

Deliberate calm is how investors should frame their strategy – try and detach from a very fraught and frightening situation and think clearly about navigating through it to the other side, guided by long term goals amidst short term volatility.
As investors, Covid-19 may teach us humility, that does not mean helplessness.

This originally appeared as an article in The Sunday Business Post March 22nd 2020