Sovereign Wealth Partners and InvestSense Pty Ltd
As you are aware, for the past 18 months we have been concerned about asset class valuations and paying particular attention to US equities, some especially expensive Australian sectors and extremely low or negative expected returns from bonds.
Whilst February’s drop in markets was not ostensibly triggered by these high valuations, we saw the stock markets drop due to a confluence of things including COVID-19 and, we believe, other factors like the possible trajectory of the US election and an industrial slow down.
We think this was part of the reason that the US led the market down and Asia actually proved surprisingly resilient in light of the surrounding hysteria.
The Australian market tumbled -7.8%, as did developed market equities -4.9% putting both the S&P 500 and the S&P/ASX 300 through their biggest one-week falls since the GFC. Emerging market equities were the clear standout finishing the month down just -1.9%. Australian REITs, Global REITs and Infrastructure fell -4.7%, -8.3% and -8.4%, respectively, while long-dated government bonds were the subsequent haven-trade, with Australian fixed interest and global fixed Interest up +0.9% and +1.2%, respectively for the month. Gold finished the month up +7.8% in AUD.
When the market falls like this the question we always ask ourselves is – do we know more than the market, either why the market might fall further, or if it is oversold, might rebound. If the answer to this question is ‘no’ we will probably not make hasty changes to portfolios, accepting that the market is generally quite efficient discounting new information quite quickly. On the other hand where there are investors involved, both men and machine, it can both overreach itself on the upside and overreact on the downside. In fact we heard Hamish Douglas, the famous portfolio manager of the Magellan High Conviction fund, espouse a similar view last week when asked why he had not made any changes. This is why, having been cautiously positioned, we have not taken more risk off the table just yet.
It is therefore with caution that we have started to form a view that maybe the market reaction to COVID-19 reaching the US could get more extreme from here. This is on the basis of country level data that we were able to scrape off the internet (specifically from the World Health Organisation). While most market observers seem to be basing their analysis on aggregate data we have started to dig a little deeper into the trends within individual countries. We can see a pattern of violent spikes in the growth of confirmed cases that has subsequently subsided quite dramatically. We are quite sure that health experts are just as keenly aware of this but are less certain that the financial media and analysts are looking at it the same way. Therefore we think it is quite possible that we will see both more extreme reactions to the downside as the virus hits America, the most watched population and market in the world, and quite valid buying opportunities as the growth rates moderate. It is not often we would be tempted to act on a micro-view of the market or a specific data point but since showing the data to one fund manager, they asked us to send it three times over the weekend. One prominent macro-economist that we showed it to on Friday also expressed a strong interest. This leads us to believe that it is perhaps information worth acting on.
Nothing is certain so we continue to move cautiously and we think it is quite possible that the market will present buying opportunities.
Looking further out we, and most people in the market, expect interest rates to decline further which will effectively force people into taking more risk and support markets. As long as a recession in the US is not imminent and interest rate expectations remain very low we will remain largely fully invested (notwithstanding the precautionary measures mentioned above). However, if that outlook was to change we would be taking a more substantial amount of risk of the table.