Markets are not as volatile as they were last month (March), but then that was the most volatile month in stock market history. Furthermore, last week was the best week for the US equity market since 1974, so, extraordinary movements are still with us, and as befits the lack of clarity around the COVID-19 virus and the various policy responses. For now, conditions for dealing remain tricky, given the size of move that can occur in the blink of an eye, and which is usually news-flow driven.
That said, we have been nudging the Lockhart portfolios a little, to improve their risk/reward characteristics where possible, to be opportunistic when we can, and to continue the direction of travel regarding our overall longer-term thesis. To this end, we recently added to our Infrastructure holdings, and subsequently to our gold and gold mining positions.
The result of this has been an increase in portfolio exposure to Real Assets, and a small reduction in the weight of “core” assets (equity and fixed interest investments). This is intended as long-term positioning, although has already worked quite well. Lockhart portfolios are up around 6% to 9%, depending on risk profile, from the lows last month.
It is fortunate that we were able to go into this period with the portfolios that we would have wanted, although setting aside the shorter pain that we all feel with the losses across financial markets, simply in terms of us then not needing to make large-scale adjustments to the portfolios and via decisions made under extreme pressure. Clearly the economic impact of policies made around the spread of the virus has significantly impacted asset prices, but we are comfortable building out the portfolios from here, and with the end-game that was previously envisaged now that much closer as a result.
One wouldn’t want to be making binary decisions right now, as the future could hardly be opaquer. As an example, Ben Breitholtz at Arbor Data Science (we are clients of parent company Arbor Research) states that his team has modelled the economic impact of the virus, and that IF the US is out of lockdown and up and running by early May, then a reasonable recovery can be made over the next 12 months.
However, if this is delayed until near the end of May, the outcome will be far more dire, in terms of the size and long-term nature of the economic and social impact. Just as doctors were worried that the crisis would be exponentially worse for each day that social distancing (and eventual lockdown) was delayed, the same can be true for modelling the economic outcome on the other side.
The risk remains that the peak in infections takes longer than anticipated to achieve, or at least that there is an unexpected second and/or third wave. Consequently, there would be a delay in the loosening of lockdown measures, indeed private companies might self-select to extend some of these anyway.
The risk on “the other side of the coin” is that economies start to recover quickly, but then policy support is removed too soon, or that the rebound is in any event less robust than had been hoped. One of the reasons that this is so tough to guesstimate is that we don’t really know how consumers and businesses will behave once we are beyond this period. Likely they will change, but exactly how, and how to then quantify this, is impossible to judge with any degree of certainty.
Our view is that although economic conditions are currently disinflationary, there are good reasons to think that inflation is ultimately coming down the track. The effective merging of monetary and fiscal policy (under political direction) and entirely unprecedented easing, via vastly more Quantitative Easing allied to government programmes (and no doubt with more to come), will result in generalised inflation. This was the dog that failed to bark in the decade after the Great Financial Crisis in 2008, when inflation only showed up in asset prices. This time round, banks are being encouraged to lend, rather than to attend to their capital ratios.
As Simon Ward, economist at Janus Henderson, puts it: “Regulatory policy has switched from brake to accelerator”. This includes in China, where “social financing” is now increasing again, and at a record rate. Increases in money supply are positive for economic recovery, but, as importantly, tend to be inflationary, hence why the gold price has a long-term link to that data set.
Economic statistics are going to be utterly appalling over the next few weeks and months. US Retail sales have just had their largest drop on record, and industrial production its biggest fall since 1946 (when the war-time economy was getting wound down). This is every bit as bad, if not worse, than might have been anticipated, and evidence of the seismic real-world impact of measures used to combat the virus.
The US has seen 650 job losses for each recorded COVID-19 death, and it is thought by some that each extra million of unemployed will then cost 40,000 lives, (perhaps due to strokes, heart attacks, suicides, increasing levels of poverty) so it is an horrifically difficult time for decision makers. Furthermore, Capital Economics suggest that most of the output lost in the first half of this year will never be recovered.
These last few weeks have made almost all nations poorer. Slow growing, demographically challenged, and highly indebted countries have “intentionally” set fire to their wealth and their previous paths to recovery. The US has already lost all of the number of jobs that it gained post the 2007/9 recession. This is one of the reasons why we are so cautious on the future of government debt (other than short-dated) and paper currencies.
It is an extraordinarily tough decision for every leader charged with deciding when to loosen or end lockdowns, whereby history will judge harshly any that (potentially) go too soon, only to effectively destroy the sacrifices and hard work already given, while leaving it too late can bring depression to a State or country. Hindsight is going to be a desperately harsh taskmaster. It is arguably a bit facetious to note, but we will, that the decisions in the UK will involve those who tend to have defined benefit (inflation-linked) pensions, as opposed to money-purchase ones.
The additional concern for President Trump, is that no President has ever been re-elected with a recession in the two years prior to polling day, let alone one so severe and recent in the memory. The November election seems set to be a referendum on his handling of the crisis, with Joe Biden simply receiving the residual outcome. As it stands, this looks like a toss-up, as the President is polling reasonably in his handling of the crisis, but then this will have been inflated a bit by “rally around the flag” sentiment. Ultimately, it is probably decisions and events yet to happen, that will decide this, so, again, another factor that investors will struggle to “handicap”.
The virus is a current phenomenon of course but will eventually be resolved and to that end there is some encouraging news on various treatments. However, the larger point, from our perspective, is the path-dependent process that has been unleashed by the response to the crisis. The impact and many-order consequences will be with us for years, and long beyond the span of COVID-19. Maybe 1/3 of the global economy is either already in the deep-freeze or has simply “evaporated”, never to come back, or at least not in its original form. The exact nature of the ultimate policy response will define whether the kindling is in place to light the fire of recovery, or whether we instead end up with damp squib and stagflation. Again, this could still go either way.
One suspects that the tax-take this year in most countries is going to “disappoint”, and may take quite some time to rebuild to prior levels. How does one then fund the Welfare State, the NHS, and all the Infrastructure spending that we are told is on the cards? Well, this goes back to deficit spending, and the monetization thereof. As we used to say even before this crisis, no politician is going to get elected on a platform of “austerity”, and this is even less likely now.
Again, one has to wonder about the likelihood of property and wealth taxes, in various forms, as, Modern Monetary Theory notwithstanding, national Treasuries will need to at least attempt to be seen to be raising funds, and groups in society with least public support will presumably be the most attractive targets for a “squeeze”. That said, at this point measures will simply have to go wherever the wealth is.
It is preserving and growing the real purchasing power of our clients’ wealth that is always our priority within the Private Investment Office at Lockhart Capital, and this continues. Governments can’t create purchasing power out of nothing, but they can create more units (by printing money) to divide into that purchasing power, and this is crucial for investors to understand, we believe.
If one uses the Great Depression as a parallel, we think that policy-makers will ensure that we avoid the initial deflationary bust (post 1929), and skip forward straight to 1932 and the start of the ramp up in (deficit) spending. The subsequent loss of purchasing power was confirmed in the 1934 devaluation of the dollar. Inflation is likely to be tolerated, and interest rates kept unnaturally low, so one must have a strategy to deal with this.
In the meantime, and as Wall Street blogger Eddie Elfenbein put it this morning “we seem to be in a race to flatten the curve before the curve flattens us”.
Andrew Wilson, Chief Investment Officer, 17 April 2020
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