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We saw the April market rally as being overdone due to the lasting impact that Covid-19 is going to have from an economic and an earnings perspective. When markets are rallying it can be easy to get caught up in the moment and invest for the fear of missing out. This is a combination of fear of missing the rally and fear of losing versus your peer group on a comparative basis.
“Economic data continued to deteriorate as earnings revisions came thick and fast.”
As such, it can take discipline to stay on the side-lines, to have conviction and belief in your positioning and to not be tempted back into equity markets that are trading at unrealistic expectations. This pretty much sums up our view of April. As economic data continued to deteriorate and earnings revisions came thick and fast, equity markets continued their march higher with very few breaks in between. It is not possible to value something using fundamentals when all the data you have is wrong or out of date.
Using pre-Covid-19 data is a pointless exercise and so equity exposure became a bit like religion in April 2020. You either believed in the power of the almighty stimulus or you did not. Unless, you are in the third camp that doesn’t really believe but doesn’t want to come out and say it so instead, goes along with the rest of the crowd.
With all developed market government bonds now negative yielding in real terms and with inflation starting to creep higher, investors are left with 3 choices; hold cash temporarily and have a shorter real term erosion of my capital, buy longer dated government bonds and lock in longer negative real returns buy equities or riskier bonds at the beginning of the largest economic decline in many decades.. In our model portfolios we have been rotating out of short dated government bills into a portfolio of short dated high quality corporate bonds.
“We continue to deploy further into single stocks that sit within our coronavirus resilient basket.”
This provides a small yield pick up while not adding to portfolio volatility. We also deployed further into some single stocks that sit within our coronavirus resilient basket. We remain with zero exposure to core equities given current valuations.
But, as the old saying goes ‘where there is volatility there is opportunity’ and the last 6 to 8 weeks have been littered with them. Admittedly to take advantage of the incredibly low oil prices, you had to own your own oil tanker but the combination of March and April has shown what I believe to be the new status quo. The last decade has been very much a delta rally with all indices moving higher depending on specific characteristics but by buying the index as a whole, you benefited from this.
The ETF industry flourished in this market on both the credit and equity side and I have been a big supporter of the usage of ETFs. We have now moved into a market where I believe it is the nimble that will benefit. Simply buying an index means you will own all of the sectors that you want to probably avoid in the current market environment. Energy, travel and tourism, hospitality and so on. Returns going forward will be driven by a manager’s equity strategy, their allocation to high yield and their nimbleness in volatile markets.
There are market movements that are indicative of a dysfunctional market; negative 3 month government bills, negative front month of WTI oil and some of the largest macro data movements ever published as the virus continues to kill. But there is hope. We will overcome this virus, or find a way to coexist alongside it. Entrepreneurs will continue to find new businesses, investors will continue to invest into them and Dolfin will continue to service them.