As 2020 dawned, our bullish outlook for both the UK and global economies remained undimmed. With lower domestic political uncertainty and the potential for reduced trade tensions between the US and China ahead of November’s Presidential election, we positioned accordingly. We saw value in both domestic and global cyclical stocks. Coronavirus has rent asunder all previous expectations. The global pandemic has caused a greater shock to asset markets than anything else in living memory. The speed and scale at which markets have moved are unprecedented.
During the initial sell-off, the fund underperformed sharply, with our overweight in aviation stocks the biggest issue. And the collapse of OPEC talks and Saudi Arabia’s decision to increase crude production collapsed oil prices, hitting our oil and gas positions. We moved quickly to increase cash and exposure to defensive large-cap stocks. This was not a decision taken lightly, but we cannot recall a time when levels of uncertainty have been higher. We have long been proponents of the ‘muddle through’ school of thought – that no matter how large or seemingly scary a situation was, society would find a way to emerge on the other side largely unchanged. Man-made problems beget man-made solutions. Coronavirus is different. It has the potential to bring about short, medium, and long-term changes to the way society is structured. As such, we feel that it is important for the portfolio to have increased liquidity, giving flexibility.
Economies around the world have ground to a halt as governments have imposed varying levels of restrictions on both businesses and individuals. In the near-term, for many industries activity has dropped to zero for at least a few months. Governments have been quick to offer support, which should help mitigate some of those impact. What remains hugely unclear, though, is the path and timeline of any exit strategy. An Imperial College study*, which appeared to strongly influence the UK government response, suggested that lockdowns may need to be enforced for over a year until a vaccine can be produced. A new model by researchers at the University of Oxford**, however, suggests that up to half of the UK population may already have been infected. This would imply that we are far closer to reaching ‘herd immunity’ and restrictions can be lifted sooner. Clearly, the market impact of those two scenarios will be very different.
In the longer-term, the enforced isolation and social distancing measures imposed during the crisis could have profound impacts. How will the urban geography of cities change? Will more people seek to live outside city centres to avoid being stuck in garden-less apartments? Will enforced remote working lead to permanently reduced demand for office space? We are wrestling with these questions and many more, while trying to ascertain what it means for our portfolio holdings and the broader market. The political landscape is also likely to change profoundly. Coronavirus has shone a light on those workers that society truly values in the gravest crisis. Shelf-stackers and nurses are more vital than fund managers. Electorates are likely to demand more latent capacity in their health services and place greater weight on the importance of a secure food supply. Supply chains will shorten. Economies that have been designed to operate at maximum efficiency may now have to operate on a less optimal but more resilient basis. This would likely come at the cost of higher taxes and lower growth.
From a portfolio perspective, a sudden realisation that coronavirus is less of a problem than is currently feared would pose a short-term challenge. In such an environment, equity markets would likely rally hard. We would still aim to capture much of the upside. This is a very rare occasion where we’d welcome an outcome that went against our fund’s positioning. In the near-term markets could rally if new cases begin to level off in Italy and the restrictions imposed take effect. This optimism could fade quickly though in the absence of a clear exit strategy from those restrictions. The US also remains a wild card, as it is unclear whether the federal government has the appetite to impose similar measures as seen in Europe. The US healthcare system could come under intense pressure over the coming months.
These are immensely difficult times for us all and we recognise that these volatile markets just serve as another layer of anxiety to be handled. As ever, we remain available to answer any of your questions. As we begin to learn more about coronavirus and its impacts, our views will continue to evolve and we will keep you updated on these through both the Value Key blog and the monthly factsheets. Finally, we would like to wish the best of health to all our investors and their families.
Neil and Craig
*Imperial College COVID-19 Response Team. Impact of non-pharmaceutical interventions (NPIs) to reduce COVID-19 mortality and healthcare demand. 16 March 2020. https://www.imperial.ac.uk/media/imperial-college/medicine/sph/ide/gida-fellowships/Imperial-College-COVID19-NPI-modelling-16-03-2020.pdf
**Lourenco J, Paton R, Ghafari M, et al. “Fundamental principles of epidemic spread highlight the immediate need for large-scale serological surveys to assess the stage of the SARS-COV-2 epidemic”. https://www.dropbox.com/s/oxmu2rwsnhi9j9c/Draft-COVID-19-Model%20%2813%29.pdf. [Accessed 26.03.2020]