Investors are still struggling to come to terms with an extraordinary collapse in economic activity, its unprecedented speed, and the fact that we are likely to be teasing out multi-order consequences, and unintended ones, from the various policy responses, for years to come.
Economic data is already the worst since the Great Depression of the 1930s and may well exceed. Eleven years of US employment growth was reversed in just five weeks, and the unemployment rate seems destined to be worse than the 1930s. However, that was a decade of high unemployment, whereas one hopes that this will be something of a temporary blip, even if the future rate remains structurally higher than that of the last few years. Nevertheless, the consumer is not in a good place, in terms of sentiment or reality.
It is hard to overstate the magnitude of the loss of economic output, wealth, and future well-being. Much of the economic activity foregone will never be recovered, and the trajectory of trend growth, already deeply unimpressive, is likely even lower now. This is not something that one can necessarily see or touch right now, which in some ways makes it easier for people to accept in trade-off for better prospective short-term health. However, for most people either their standard of living will drop, or their future quality of life will not be what it once should have expected to be.
The policy response has been suitably gargantuan, and fundamentally changes the financial landscape. We expect inflation, further down the line, but after a period of disinflation first, probably for a year or so, but who knows?
This week saw history being made in the oil futures markets, with negative prices for the first time, as the world is rapidly running out of storage options for oil that is still being pumped despite the collapse in demand. This is particularly bad news for higher cost producers (we discussed the vulnerable US fracking operations in Q4 last year) and will have serious implications for the Canadian tar sands operators, and for what is left of Venezuela, as examples.
One might expect markets to go side-ways at best, in the near-term, following the size of the rally off the March lows, or at least that which happened in the US. There have been a few positive signs, but market participants might want to see higher beta (more volatile) stocks perform a bit better, and some of the previous winners do a little less well, relatively, to gain more confidence that the worst is behind us. Additionally, the bond market is again not quite telling the same story as the equity market, and it would be supportive to see two years Treasury yields push out a bit, to suggest that a future recovery was on the cards.
On the downside, what one really does not want to see is problems in the housing market, which tend to occur when economies are really beginning to spiral and mark out the very worst recessions. On that note, it is unfortunate that housing entered this period at already quite punchy valuations, although mortgage rates remain incredibly low (if harder to get as new). It will be interesting to see whether property taxes are forthcoming, as that will tap one of the few areas of significant wealth available to governments, although might cause an unpleasant correction in prices that further exacerbates the recession unnecessarily. Probably best to tread carefully.
We are in the process of reducing risk within the fixed interest element of the Lockhart portfolios. Central banks are becoming rather lonely buyers in this space, and although their support has been extremely beneficial to prices here, this in fact provides quite a nice opportunity to take advantage of their largesse, batten down the hatches a little, and rotate further into ultra-short dated debt.
We are also in the process of rebalancing our ESG portfolios, to maintain the appropriate level of risk and diversification there. This is an important part of that process, and happens, formally, twice a year.
The additional weight in gold and gold miners in the portfolio has continued to perform well, and arguably gold is sniffing out future inflation and the impact of deficit spending and likelihood of debt monetization. However, these positions are really for the longer term rather than right now and are perhaps getting a little ahead of themselves.
Whether the gold price will consolidate or retreat enough for us to be able to buy more, at attractive prices, we do not know. Long-term clients may enjoy the irony of the position in gold miners, given our antipathy towards them in the “noughties” when we favoured simply physical gold. In those days miners were fearfully expensive, and were always going to lose market share to physical gold which, from 2004, could be bought inside an ETF. In the last couple of years, we have felt that the miners were now starting to offer value, having de-rated, and so we hold them in partnership with the physical gold ETF. They retain significant levels of volatility though, and given that the gold price rarely trends smoothly, even at the best of times, it can be best just to tuck them away for the long term.
The key question of course is when and how does “re-opening” occur. Given that the virus risk seems minimal for under 50s with no pre-existing conditions (I may regret writing this), at least a phased roll-back must be imminent, even if lockdown continues in varying intensity and areas for a year (as South Korea’s CDC suggests). A re-opening is, naturally, entirely necessary for the economy to return to normal, and every day counts, but just the act of ending lockdown won’t be enough on its own. A CBS poll this week showed that, when the economy re-opens, less than 30% of people say they will feel comfortable going to a bar or restaurant, and only 15% in getting on a plane. Those kinds of numbers are just not going to cut it.
The US Federal Reserve meet next week, and there will also be the initial estimate of first quarter US GDP, so there could be significant news-flow to contend with. We are pretty happy with the composition of the Lockhart portfolios right now, so hope to be able to adapt, and even be opportunistic, should some volatility be a consequence of those events.
Meanwhile, Congress has passed the $484bn coronavirus relief bill, which is a positive even though it is arguably too small and will need to be topped up. The Bank of Japan is suggesting it will discuss “unlimited” bond buying, at its next meeting, which is yet another extraordinary milestone. The Eurozone, though, is in danger of lagging behind, in terms of policy response, and size thereof, though we would expect them to get their act together at the 11th hour, assuming that has not already passed…
Andrew Wilson, Chief Investment Officer, 24 April 2020
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