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The market’s true bottom is still ahead of us.
- We anticipated the global correction in equities and insulated our discretionary portfolios accordingly.
- Although we do not believe we have seen the bottom of the market yet, our redeployment strategy is now being implemented.
- We continue to buy companies within our resilient basket and, when we believe the market has bottomed, we will start buying quickly into our recovery basket.
This has been a challenging quarter on so many levels. A rollercoaster for clients, investment professionals and consumers alike. We started the year, in our opinion, at such stretched valuations that we were severely underweight equities just as the coronavirus news was breaking. For our conservative portfolios this meant that we were at single digit exposure to the equity markets. We monitored the situation closely as it developed in China and realised early on in February that this was going to be both global and incredibly impactful. Although we did not foresee the current self-isolation being enforced in Europe quite as quickly as it was, we realised that equities were going to correct substantially, this was going to be a global correction and certain sectors were going to be much heavier hit.
“Our realisation of the extent of the virus’ impact allowed us to protect our discretionary clients from a large proportion of the downside.”
On 11 February, although equity markets were still climbing slowly, we briefed our teams internally that the market was going to deteriorate substantially over the subsequent weeks. As the markets continued to climb and we received research report after research report from large institutions telling us that there was nothing to worry about, we started de-risking our client portfolios even further. We sold all mining and energy exposure on both the equity and debt side, our high yield exposure and any instrument that had exposure to the tourism sector. This process was completed by early March and this mitigated the extent of the market drawdown seen in March. Although we did not foresee or predict the virus, our realisation of the extent of the impact allowed us to protect our clients from a large proportion of the downside.
The scale of measures already introduced by central banks and governments demonstrates how fearful they are of the economic impact of the coronavirus. Our fear is that central banks, aside from the provision of liquidity, cut interest rates too soon to shore up confidence. Going into this economic downturn interest rates were substantially below where they would normally be – providing central banks with limited ammunition to combat the economic impact of the virus.
It has certainly been a busy time for our investment team. We have been navigating what are some of the scariest markets that we have seen for the last 12 years, avoiding the majority of the drawdown for our discretionary portfolios, while having to set up our working from home offices, continue to communicate effectively and work out how to redeploy out clients’ assets.
“We have already started nibbling back into the markets.”
To that last end, from the middle of February we started working on our re-deployment strategy. In the middle of March we presented this via webinar. We have developed two baskets for redeployment – a Coronavirus Resilient basket and a Coronavirus Recovery basket. We have already started nibbling back into the markets in our resilient basket – purchasing Amazon, MasterCard, Alibaba, JD.com and Alphabet across our discretionary mandates just before the markets went on one of their biggest 3-day rallies for 90 years. We took the opportunity to reduce equity exposure in our UK-only portfolios following this rally.
The most important question, and the one that we are now most often asked by clients, is ‘have we seen the bottom of the market?’ Our view on that – not yet. We have seen the monetary and fiscal responses upfront from around the world. What we have only recently started to see is the economic impact – we have seen a small number of data points filtering through – the largest US jobless claims ever. Not just the largest, but a multiple of the second largest. Some of the data coming out from China has been scary. Some of the forecasts, of US Q2 annualised GDP at -25 per cent is shocking. I believe that the market has rallied into the end of March on hope following the scale of the announcements by governments and central banks. I fear that the reality of the virus will come back to hit the markets – from a quarantine perspective combined with a dry up in consumer spending leading to increased bankruptcies. It is simply not possible for the government to bail out every company. The other element here is time. I write this letter to you all from my dining room table. I have no idea whether I will be writing the next quarterly letter from the same location or from back in the office. I would not be surprised if the next letter is also written from my house. If so, this uncertainty and quarantine spills across to Q3.
“For a true bottom, we need to see both the rate of new infections and deaths start to slow.”
That leads me onto my final look forward point. What will stop the declines and what will indicate that we are in recovery mode? Sadly, I fear that the death toll will continue to increase, and substantially so. I suspect that the entire developed world will face a period in strict quarantine to try and space out the spread of the virus to enable the health services to deal with the patients. Currently the number of infected and the number of deaths are both increasing exponentially – despite the best efforts of hard working doctors and nurses around the world. For a true bottom, I think we need to see both the rate of new infections and deaths start to slow. Markets trade on future expectation – but I believe this gets worse before it gets better.
We have experienced the ‘virus decline’ – I believe the ‘economic decline’ will come once we start getting more economic data combined with company earnings and Q3 guidance. Does the S&P500 break through 2,000? Honestly, I have no idea. Our strategy is to continue to buy companies within our resilient basket throughout this period of market volatility and then when we believe the market has bottomed, we will start buying quickly into our recovery basket along with adding core exposure back into equities. We have our strategy and we focus on deploying this whilst knowing that our clients are currently able to relax knowing that their discretionary portfolios have limited exposure to equity markets.
Dolfin’s investment team is working remotely at full capacity. We are here to discuss our latest ideas, deployment strategy and updated performance numbers with you. Please contact your relationship manager if you would like to arrange a call or video meeting. In the meantime, I hope that everyone stays healthy and safe and we look forward to catching up over the coming quarter.
Past performance is not a reliable indicator of future returns. Forecasts are not a reliable indicator of future returns. If the information is not listed in your base currency, then the result may increase or decrease due to currency fluctuations.
If not otherwise indicated, all graphs are sourced from Dolfin research, April 2020.
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