Firstly, it is worth noting that the recent market events have been unprecedented and quite extreme, even for the most experienced investment teams across the globe. We have an unfolding global pandemic, alongside a major plunge in the oil price on fears of a potential oil war. All happening in a world more interconnected than it has ever been both physically and digitally through social media.
Markets have been driven down precipitously, primarily due to concerns around global economic contraction resulting from the spread of the Coronavirus (COVID-19). A compounding factor is the tensions between Saudi Arabia and Russia which has resulted in a major increase in oil supply, causing prices to decline by its most in almost 30 years.
The South African government declared a national state of disaster on Sunday evening. The president announced a range of containment measures relating to travel, large public gatherings and quarantine protocols in order to limit spread of the virus.
The natural response is to compare the current circumstances to history and see what lessons can be extracted from previous virus outbreaks and market crashes. A Severe Acute Respiratory Syndrome (SARS) virus hit china in 2003, infecting at least
8 000 people and killing around 800 (a roughly 10% fatality rate). The effect on the market was material but short lived and it subsided in around a month. This pattern of swift recovery (< 6 months) was repeated for outbreaks of Swine Flu, Ebola and Zika. However, the major difference today is that China’s gross domestic product is four times the size it was in 2003 and the globe is far more connected than it was almost two decades ago.
The global financial crisis (GFC) was essentially driven by overextension of credit that ultimately resulted in a stock market crash and a major economic contraction. This time things are switched around, the concerns around the virus are resulting in a material reduction in economic activity which will ultimately lead to a meaningful output contraction. While it isn’t our base case view, the likelihood that this eventually spills over into a financial crisis if authorities do not appropriately manage the situation cannot be ruled out.
At the time of writing the Johannesburg Stock Exchange (JSE) had fallen more than 30% since mid-February, while the S&P 500 had fallen close to 20% over the same period. These are some of the swiftest declines in recorded history and warrant careful assessment and investigation. The VIX Index (colloquially referred to as the fear index) hit levels not seen since the GFC.
Daily volatility was so high that the United States (US) stock market hit the so called “circuit breaker” levels of decline where trading is suspended for 15 minutes to allow trades to clear before resuming. The All Share Index had its worst one day decline on 12 March 2020, since 28 October 1997.
Evaluated through any lens, the market movements over February and March will hold an infamous place in the history books.
If not for the magnitude of declines, then certainly for the pure velocity and speed with which they receded into bear market territory.
Our portfolio management approach hinges on forming a view of the most likely outcome given the prevailing circumstances, what we term our “base case” scenario.
In our assessment, the current market and economic turmoil is likely to be transitory in nature and we expect it to subside towards the end of 2020 (although precise timing is very uncertain). This base case is predicated on strong, coordinated global fiscal and monetary policy response to alleviate the stress created from the impending economic contraction and to avoid further degrees of financial stress in the system.
It is also prudent to consider that in circumstances as uncertain, unprecedented and as fluid as those we currently face, the risks to our base case scenario are material. As such, we construct a stress scenario whereby the required fiscal stimulus is insufficient and/or the combined impact of the virus and oil crisis is much worse than anticipated, resulting in the financial system becoming increasingly stressed. In this scenario, the result would first be economic contraction, which then leads to a financial market crisis. While the likelihood of this occurring is currently quite low, considering its possibility allows us to adequately prepare our portfolio responses for such a scenario.
The following summarises our current house view portfolio positioning:
- Our portfolios remain well diversified and defensively positioned
- Our offshore exposure remains close to the regulatory maximum
- Our local bond exposure remains overweight
- Our South African equity exposure is underweight
- Within the equity exposure (the largest part of our balanced portfolios), we are underweight cyclical businesses (e.g. resources) and overweight rand hedges and defensive counters (e.g. food retail)
The above positioning is being rigorously debated and reviewed on a daily basis given the current high levels of market volatility. We are reassessing our base case, not losing sight of the stress case and are well prepared to adjust our portfolios accordingly.
The world is first and foremost facing a major public health crisis and our thoughts go out to those affected by this human tragedy. The response by authorities to contain the spread will undoubtedly be negative for the global economy. The magnitude and duration of this is uncertain and will depend on a host of factors which need to be closely and consistently monitored.
Our investment team is highly experienced, and despite the unusual nature of this market disruption the experience of previous market dislocations is proving invaluable in remaining composed amidst adversity. We understand such times can be troubling for investors and we encourage you to reach out to our team should you need any further information.