The key takeaways from the current crisis.
For me, there are two key takeaways: first, almost all market downturns fade into insignificance in the long run, even if at the time they may feel unprecedented and game changing. Second, it is dangerous to sell out of markets completely, even for very short periods of time.
Both considerations have framed the way we have positioned portfolios during the crisis. This year’s sell-off in global equities was one of the sharpest ever, with markets falling over 30% in little more than 30 days. The temptation at the time, with panic in the air and forecasts of the economic downturn becoming more extreme by the day, was to hit the sell button.
Instead, we held our nerve. We went into the crisis broadly neutral on equities. By that, we mean the allocations to equities were in line with the weightings we deem appropriate in the long term for each risk profile. When market declines left portfolios underweight, we took advantage of the lower prices to top up our positions and return to a neutral position.
Markets typically see sizeable increases in the early stages of a recovery from a bear market, and it is essential not to miss these gains. This time has proven no exception. In fact, the rebound from the lows on 23 March has been one of the swiftest ever – just like the sell-off before it.
Global equities are now up over 25% from their lows, recovering more than half their losses. The rebound is down to two main factors: the massive fiscal and monetary stimulus now put in place around the world, and the recent peak in infection rates in many countries which is leading to the easing of lockdown restrictions. Both developments are undoubted good news and reason for the markets to become more cheery. However, we are sceptical that they justify quite such a fast rebound. Unprecedented stimulus has been put in place only because of the unprecedented severity of the downturn.
Markets seem now to be assuming that there will be a V-shaped recovery with economies rebounding quickly. But this seems unlikely. Lockdowns will be relaxed only cautiously, and will only be sustained if there is no secondary spike in infections. Social distancing also looks set to remain in place at least until year-end, which will prevent some sectors from returning to any semblance of normality any time soon.
In short, we believe it is quite likely over coming weeks or months that the market could fall back again, albeit not to their March lows, before seeing further sustained gains. We have therefore recently reduced some of our exposure to UK small and mid-cap stocks, leaving us with a small equity underweight.
Recoveries are usually led by small and mid-cap stocks and the more cyclical sectors. But this time, it is much less clear this will be the case as it hard to believe there won’t be significant scars from the brutal downturn in activity. We believe quality stocks with strong balance sheets should fare well in what will remain quite a challenging environment. When we reinvest the cash we have recently raised, we plan to reinvest in this area.
Importance of diversification
One lesson to be drawn from this crisis is the importance of diversification. Bonds, and indeed gold and alternatives, are an essential part of most portfolios because of the protection they can provide in serious sell-offs. But diversifying one’s equity exposure is also critical.
UK equities, particularly FTSE 100 companies, have a high proportion of their earnings coming from overseas. But this does not remove the need for a sizeable exposure to international stock markets. Year-to-date, for example, international equities have held up much better in sterling terms than UK equities, falling 7% compared with 19% for the FT All Share. Currently, the UK comprises 35% of our equity holdings.
Wild-card for markets
We also believe it is important not just to allocate to individual equity regions but also to specific themes. Even in times such as these, some areas can prosper. We have had specific allocations to companies focused on technology and artificial intelligence for a number of years, and they have held up very well in the sell-off. Looking forward, the new normal looks certain to continue to favour such areas.
At the end of the day, while Covid-19 has left portfolios nursing losses, the damage has been contained by appropriate diversification. Although coronavirus clearly remains something of a wild-card for markets near term, we strongly believe it remains appropriate to retain a sizeable exposure to equities. Indeed, over the next year or two, we expect portfolios to regain their recent losses and more.
Chief Investment Officer