The S&P 500 fell a further 12.5% in March and was at one stage down almost 31% since end-December before somewhat of a relief rally brought the total performance year-to-date to a miserable -20%. By comparison, the MSCI All Countries Index was down 21.7%, reflecting the fact that emerging markets (EM) have been harder hit than developed markets (DM). Of major markets, the Shanghai Composite Index has performed better than most, being down only 9.8%.
The somewhat disjointed approach to the Coronavirus (COVID-19) crisis by the US has translated to a very high degree of uncertainty around the trajectory that the virus will take. With many mathematical models predicting disastrous outcomes, the inordinately flexible US labour market reflected how smaller businesses in particular would respond; initial jobless claims in the third week of March hit a record 3.3 million before doubling again the following week to reach a shattering 6.6 million. By comparison with the peak in claims in the 2008 Global Financial Crisis, claims hit a peak of 665,000 in late March 2009. This is already 10 times as high as that, and the worst may still lie ahead.
This inevitably points towards the extraordinary economic impact the health crisis will have. While these numbers are US-based, it is indicative of the broad global response and has triggered central banks around the world to hastily cut interest rates. The Fed cut interest rates twice in March, bringing the Fed funds rate essentially to zero percent. While this monetary policy stimulus will do little to ease consumers’ plight, fiscal stimulus to provide support for individuals as well as corporates is also on its way, with the US Congress approving a fiscal stimulus of over US$2 trillion, representing almost 10% of gross domestic product (GDP). The enormity of the economic impact in terms of a countrywide lockdown is only now becoming apparent and there are already calls for even greater fiscal stimulus.
Markets are of course concerned that the economic slowdown will degenerate further into a full-blown credit crisis, in which rising credit defaults (i.e. a solvency crisis) triggers a banking crisis, akin to what happened in 2008. This has seen a dramatic rise in credit spreads, both in corporate as well as sovereign EM. A desperate search for liquidity on a global scale saw the US dollar as well as US Treasury bonds rally strongly, while most EMs saw their bond yields and currencies weaken dramatically.
Adding fuel to the fire, a major disagreement between OPEC and Russia over proposed supply cuts saw oil prices, already hit with a demand shock due to the COVID-19 crisis plunge further, before bottoming below US$20 bbl. While this will be particularly negative for energy companies, as well as oil exporting countries, it will provide some of the ingredients for economic recovery going forward, especially if prices remain below US$25 for a number of months. The MSCI World Energy Sector Index is down over 45% year-to-date. Highly leveraged energy companies are most in the firing line which is shown in the dramatic increase in credit default swaps (CDS) spreads. 5 year CDS spreads for Investment Grade (IG) Energy sector started the year at 97 basis points before rising dramatically to the end March at 419 basis points. By comparison, the sub-investment grade or High Yield (HY) equivalent rose from 546 basis points at the start of the year to 1388 basis points.
Globally, the enormous focus on mitigating the economic effects of the COVID-19 crisis will be required, and while there may well be a V-shaped recovery at the end, it is highly likely that the stimulus measures will need to be in place for much longer than the health crisis continues. This will ultimately be to the benefit of financial markets.
We remained underweight overall in our equity positioning but have already begun rotating risk within the funds. In particular, we reduced our underweight Europe position rotating away from global EM exposure. Within Europe, we have initiated a move away from smaller company exposure to growth oriented corporates, reflecting a desire to focus on quality. We also shifted away from direct exposure to India equity in favour of broader Asia EMs.
Given the backstop that many central banks have created through access to liquidity as well as funding lines, we believe a step-wise approach to adding risk makes sense. Firstly, by rotating equity risk on a regional and sectoral basis away from areas which remain vulnerable towards those that are more robust or have implemented risk mitigation strategies. Secondly, by increasing exposure to higher quality default remote assets, such as IG corporates, where spreads are at very attractive levels, and then thirdly by increasing overall equity exposure and away from current cash holdings.
As would be expected, it was a negative month in performance terms. The Ashburton Global Growth Fund was down 11.1%, although it should be seen in the context of the MSCI All Counties Index move of -13.7%. The more defensive funds were also down with the Ashburton Global Defensive Fund down by 7% and the Ashburton Sterling Asset Management Fund delivering a return of -7.3%. Underlying stock selection has been disappointing, but our broad asset allocation positions and FX positions have helped mitigate that. We expect our phased approach to increase in risk within the funds will bear fruit once the markets begin recovering.