Over the last few weeks, we have experienced heightened volatility in global markets. This culminated on Monday with one of the worst days in global equity markets we have seen for a long time.
As you will all know, we have been expecting the bull market of ten years plus to run out of steam at some stage. It has been almost three years since I joined Taylor Money to help Jonathan, Phil and Paul manage clients’ portfolios. Our specific focus has been to ensure portfolios are robust enough to weather a more volatile market environment following a long bull market.
We did this by increasing exposure to global bonds (company and government debt), gold, alternatives and specialist commercial property. This has proved to be invaluable.
Whilst every client’s situation is unique to them, we are typically seeing that the average portfolio has fallen considerably less than equity markets in the year to date.
During his forty years in financial services, Jonathan, the founder of Taylor Money, has witnessed many major corrections and market crashes. Most notably, Black Monday in October 1987, the Dotcom crash in April 2000, the terrorist attack on the World Trade Center in September 2001 and the collapse of Lehman Brothers in September 2008 which proved to be the catalyst for the Great Financial Crisis.
Though at the time it has felt as though the world was coming to an end, in all these cases markets and investors have proved to be very resilient and inevitably markets have always moved on to greater heights.
We believe there are three overarching factors causing the recent shift in sentiment and subsequent pull-back in markets.
- The actual and feared impact of the Coronavirus on supply chains and aggregate demand from consumers and businesses which will inevitably reduce global economic growth.
- Central banks’ perceived limited ability to inject further liquidity into the financial system.
- Saudi Arabia’s decision to launch a price war leading to a sudden c. 30% decline in the price of oil.
Like many times before, the world economy, and in turn markets, are facing a period of uncertainty. Volatility in markets is nothing new and this most recent wobble has arguably been a long time in the making, especially given that we have just experienced one of the longest periods of expansion on record.
We realise that knowing this provides little comfort during a sell-off. Every investor inherently feels a certain amount of panic. But, despite our natural instincts, it is vital to remain pragmatic and consider the facts available to us rather than be led by our feelings alone.
With all of this in mind, here are a few things we are currently thinking about:
- News outlets continue to produce endless headlines regarding the spread of coronavirus but with little context. This is unhelpful as it can stop us having a clear picture of the situation. For example, though there is now a total of c. 127,860 recorded cases (as at 12/03/20), c. 68,300 of these have now recovered and are no longer active cases. We have been using this website to monitor the situation accurately rather than relying solely on the media.
- The infection rate in China has fallen significantly following their aggressive response to the outbreak and economic activity is slowly beginning to pick up again. By looking at recent migration patterns, we can see that workers are beginning to return to key manufacturing cities in China. In addition to this, daily coal consumption, which reflects the demand for electricity and energy and in turn is a good indicator economic activity, is now back up to 80% of where it should be at this point in the year.
- Though the spread of the virus is building momentum in Europe, with Italy leading the way, it is clear governments are willing to take drastic action to help contain the spread. Using China as an example, providing governments put in the necessary controls, it could be somewhere between two or three months before things start to return to normal. Hopefully, swift action from governments, combined with warmer weather as we move into spring, will slow the spread of the virus and therefore reduce its long-term impact.
Policy Response and the Economy:
- To reduce the economic impact of Coronavirus on the global economy, officials will need to act quickly in providing effective support to the consumer, small business and financial markets. For this stimulus to be most effective it needs to be deployed in a meaningful and timely manner.
- Governments around the world are already proposing and enacting massive fiscal policies with the aim of reducing the economic impact of the virus. These measures look to diminish the strain put on small businesses and individuals as self-isolation and lockdowns stop people from working and spending as usual.
- Global central banks have also acted quickly to support financial markets by providing additional liquidity and cutting interest rates. The US Federal Reserve, Bank of England and Hong Kong Monetary Authority have all announced 0.5% emergency interest rate cuts. We would expect to see others follow suit shortly. As we enter the recovery phase with lower interest rates, lower oil prices and high government spending we could see a rapid bounce in the global economy and ultimately financial markets.
Oil Price Drop:
- Monday’s oil price fall of 30% shocked markets and impacted energy-heavy benchmarks, such as the FTSE 100, the most. However, lower oil prices can act as a tax cut for consumers and also benefit the economies of countries which are net importers of oil such as China, India, Japan and Germany.
- Saudi Arabia’s breakeven price (price to maintain current government spending using oil revenues) is $80. Therefore, it is unlikely that they can afford to keep the price of oil around $30 for any considerable length of time.
Market Volatility and Portfolio Implications:
- Market moves are becoming bigger and faster. This is partly due to an increase in the number of quantitative and algorithmic trading strategies and a reduction in the liquidity previously provided by proprietary trading desks and market makers at investment banks.
- Volatility tends to cluster. In other words, we usually experience big up days in markets following big down days. Knowing when these will occur is impossible, so it is usually best to remain invested and ensure you take part in the upside and not just the downside. We have talked about this in the past.
- Despite their low starting yields, bonds still play an important role in a diversified portfolio and have provided significant protection during recent weeks. Investing in different asset classes means that news headlines are rarely representative of actual returns in portfolios.
We all know that to earn higher returns in the long run we must occasionally pay the price in the short term. Unfortunately, knowing this does not make it any easier when payment is due.
You’ve stuck around for the risk, you might as well get the return.
General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.