Dramatic end to month
February fall fastest us stock market correction ever.
February will go down as one of the most volatile months in history for asset prices with dramatic moves as news broke the novel Covid-19 virus had spread from its epicenter in Wuhan to other parts of the world. A global pandemic was now not only possible, but likely. The weekend of 22/23 February was the turning point. Investors recognised it was unlikely the virus was going to be contained to China. By the end of that week new infections outside China exceeded those inside China. During such periods of uncertainty investors sell risk assets and shift to safe harbours. The February fall was the fastest US stock market correction ever and the yield of US10 government bonds, widely considered the safest of safe havens, fell to a record low of around 1% from a high of 1.65% only a few weeks earlier. Gold rallied, the US dollar strengthened, and credit spreads widened.
In short, and perhaps an understatement, it was a dramatic finish to the month.
What did we do?
At the start of February, we prepared a portfolio management plan, based on three market impact scenarios which we shared with investors in our February newsletter, being:
Scenario 1. a brief painful period followed by recovery;
Scenario 2. a sustained period of ongoing uncertainty, speculation again ending with recovery;
Scenario 3. a genuine global crisis centred on a pandemic with lasting economic consequences.
After the weekend of 22/23 February it looked like scenario two was playing out, so we increased hedging levels and generally reduced risk. This resulted in our funds performing better than their market index. While it’s still a loss, we believe its good defense – goals saved compared to what would have happened had we done nothing.
We had no crystal ball and no more information than anyone else. So, I am comfortable we took appropriate steps, in ambiguous, rapidly moving circumstances, to protect investor capital. We saw – and are still seeing – a lot of indiscriminate selling, particularly with our small cap portfolios, where it was baby out with the bathwater. This has resulted in valuations looking much more reasonable again. And because we used futures for much of our defensive market stance, we are much better positioned for a rebound than if we had relied solely on raising cash levels (which requires selling companies we own). We don’t have to buy companies back to benefit – that can be difficult, especially with smaller companies. With futures we can simply close some, or all, of the contracts to increase our exposure to the companies we have (and others we buy because they’re oversold). This is a lesson we’ve learned from the first quarter of 2019, discussed in the January issue, when we held cash for too long.
We’ve travelled similar roads before and each time the world, and the general collective, has solved each and every crisis we have encountered. I have complete faith the global collective will do the same this time.
As a first port of call, we expect a strong policy response from Central Banks and governments around the world in the coming weeks to combat the economic slowdown and to calm investors.
Such a response will likely allay many of the fears and provide a much-needed confidence boost.
Of course, blood on the streets provides opportunities to review and identify assets you want to own long-term in your portfolio. As you would expect, the investment team has a shopping list.
Further to this, there are winners during such dramatic shifts in behaviour. Obvious ones right now include pharmaceuticals, infrastructure, streaming services – Netflix’s stock price has barely moved so far – and delivery services.
It’s still unclear how long and to what extent Covid-19 virus will affect consumer behaviour, as is its overall economic impact. My best guess is that it will be severe, but short-term.
With coordinated policy support, the downside economic scenario will be mitigated. But like the virus, this situation is live; we can only go with what we know when we write this.
In summary, we don’t like to see suffering or harm; but our view is the world recovers from this, economies continue to grow, and good businesses do well long-term.
Like when you or I get the flu, it knocks you for six, but ultimately you recover, and life goes on. I expect markets will get over the flu this year and while some behaviours will be impacted long-term (a change in consumer behavior, such as increased demand for delivery services for basic items or an increased focus on hygiene (to prevent the spread of cold & flu viruses), most things will return to normal relatively quickly. The human race is hard-wired to get on with life, whatever the setbacks. This time is no different.
Mike Taylor, Founder and CEO
Past performance is not an indicator for future performance. This is not intended to be financial advice and does not take into account any particular person’s circumstances. Before relying on this information, please speak to an independent financial adviser.