Market Comment 12/03/2020
Cornelian's comment on market moves - 12th March 2020
Our Chief Investment Officer Hector Kilpatrick outlines Cornelian's views on the global outbreak of the COVID-19 virus, and what this means for markets.
Over the past month, equity and credit markets have fallen substantially. COVID-19’s spread outside China has caught investors’ attention and worst case scenarios are being assessed. These centre on both a supply shock (where components can’t be delivered for final assembly) and a demand shock (where end demand disappears as developed economies go into ‘lock down’). Some sectors are more vulnerable than others. A case in point is leisure, where Carnival Cruises has just announced that its 18 Princess branded ships will halt sailings for 60 days.
Putting the potential for the infection rate to diminish during the northern hemisphere’s summer months to one side, it is clear that the more aggressive the economic lock down, the greater the chance that COVID-19 can be eradicated. This therefore, generates the perverse requirement for a sharper, short term political and economic response in order to deliver a quicker, more effective resolution and the return to business as usual. The threat of near-term economic gridlock has led to a collapse in investor confidence but arguably, following recent market moves, the threat of a more severe lock down should be embraced.
If we were having to contend with COVID-19 in isolation, we would argue that the impact of the virus’ spread would probably be to elongate the economic and investment cycle as the combination of reduced end demand and the resultant policy stimulus would drive a recovery in risk asset prices.
However, the advent of an (artificial) oil price crisis exacerbates the issue and increases the risk of a structural down leg in the cycle. Russia’s well-timed intervention in the oil market, which has driven the oil price down, brings with it the spectre of a turn in the credit cycle where defaults in the onshore shale sector in the US infects the bank sector’s willingness to lend to companies in other sectors.
We, therefore, believe that in the very near term confidence could be undermined further as Russia and Saudi Arabia follow through with their threats to increase oil production, driving the oil price down further still, and developed market governments ramp up their response to the COVID-19 virus.
One can argue how long COVID-19 and the induced collapse in the oil price will take to play out, but it is essential to realise that both issues are likely to be temporary. The worst case scenario for COVID-19 has to be that we have to endure another winter with the virus before mass vaccination can take place, whilst the oil price weakness will depend upon the strategic goals of Russia and Saudi Arabia.
A rapid recovery in confidence could materialise astonishingly quickly if European countries are able to demonstrate an ability to contain the virus within the next two to three weeks, whilst the Russians and Saudis could come to their senses at any time. In this scenario, being too defensively positioned would be costly.
Following the first market tremors concerning the coronavirus in China, markets recovered and we top sliced some equity positions (mainly international equity ETFs) on the bounce. Then, as it became clear that the risk that the virus might spread globally increased, we reduced equity exposure further by top slicing some international equity ETFs as well as reducing UK equity exposure. In doing so, we reduced the UK equity portfolios’ exposure to economically sensitive stocks. Some of the proceeds were invested in an infrastructure fund and also in gold.
On Monday, 9th March, we took the decision to sell the funds’ holdings in the Royal London Sterling Extra Yield fund. The proceeds are being held in cash.
The fund has delivered strong returns over many years but is focused on some of the less liquid, higher yielding parts of the sterling corporate bond market. We continue to hold manager, Eric Holt (and the wider credit team at Royal London) in high regard, however with reduced liquidity and credit rating downgrades likely, conditions in credit markets are deteriorating and we felt it prudent to crystallize gains.
The Cornelian funds therefore, are cash rich and we are awaiting the right time to add risk back materially. Whilst timing is impossible to predict, we cannot discount the possibility that this might happen in the very near future.
Whilst we have been fairly conservatively positioned, we have observed a mixed performance by some of our diversifying assets, which has been frustrating. For example, infrastructure funds are being sold by index tracking ETFs as they receive redemptions and this is driving the infrastructure company share prices down in the short term. Whilst one of the hedge funds held has performed strongly, two others have negotiated the period poorly, which is disappointing.
In fixed income, our short duration credit funds have held up nicely and our strategic bond managers have performed relatively well.
In international equities, the Findlay Park North American fund has performed exceptionally well helped by its high allocation to cash and the Polar Capital Global Technology fund has performed strongly in relative terms as has the Schroders Global Convertible fund.
Year to date, our UK equity portfolio has outperformed its benchmark.
Whilst the market moves of the last month have been brutal, there are good reasons to remain invested. Ultimately, we believe that it will be proven that the economic cycle has been extended, not destroyed, by these events. We anticipate strong policymaker responses to be announced to help buttress economic and investor confidence and sense that investors are beginning to capitulate, which is a prerequisite for identifying peak pessimism, and therefore, the optimal buying opportunity.
Chief Investment Officer