“If you change the way you look at things, the things you look at change.” – Dr Wayne Dyer, an American self-help author and a motivational speaker.
As we locked down in late March, it was hard to imagine that we would see global markets return to the levels of pre-lockdown society as early as June. We have just lived through one of the most volatile quarters the world has borne witness too. Volatility has not only been prevalent in the financial markets but in the emotions of every one of us during unprecedented recent events. Protests, riots, a demand for change; all while COVID 19 remains a severe threat to the vulnerable and elderly.
However, our portfolios are built to withstand these types of events. By using over 100 years of historical data, we build global portfolios, best positioned to capture the returns of the continuously resilient global economy. Figure 1 below depicts this ideology. Although we switch on the news and find the economic outlook to be a dim affair, one must be disciplined to find facts through the noise. Whilst the shouting and screaming has come from those quoting the decline of the popular market indexes such as the FTSE 100 and S&P 500, the global market cap weighted index, upon which your portfolios were built, has returned to exactly where it was at the beginning of 2020. Thus, the value of your portfolio will most likely be just shy of the value it held whilst you toasted your drink on New Year’s Eve to a prosperous, uneventful and stress- free 2020.
To heed the advice of Dr Dyer, let’s look at things in another light. Instead of financial loss, let’s look at this in the perspective of time lost or “delayed gain”. The average recovery period from a bear market for the FTSE All-Share is 648 days. The current global market cap recovery is nearly complete as shown above, and we are only through 135 days. For a globally diversified investor, this has been an extremely fast correction so far.
The fastest 30% drawdown in the history of global equities in the first quarter, followed by the largest 50-day advance in market history in the second quarter has not been easy to digest. Nonetheless, it is out of our control! Unless by the off chance you happen to be a global economic policy maker, the chances are you are pretty helpless during a global market crash correction. Not to fear, an investment is a long-term journey that we have been prepared for from the start and like anything there is a price for admission – occasionally we have to wait and stay patient during market downturns before continuing in the upward trend that is just around the corner. Please see the Growth of Wealth chart in the Appendix; corrections have occurred before and will happen again, pay your admission and keep going.
Due to the recent lockdown, there have been significant restrictions on trade in key sectors along with a severe limit on travel. Global tourism, retail and other key industries have been crippled, meaning the economy may have some way to go before it sees a return to its normal prosperity. We know one of the best measures of economic productivity and output is the Gross Domestic Product (GDP) indicator. In Figure 2, we have used data from the IMF and the World Bank to map GDP back to 1961.
Whilst we have seen a massive contraction in GDP over the past months, this data shows that the decline is not out of line with past GDP cycles. The pattern of GDP growth reflects the natural business cycle phases: expansion, peak, contraction, and trough. They do not occur at regular intervals, but they do have recognisable indicators. The third phase, indicated by the arrow in Figure 2, is a contraction. It starts at the peak and ends at the trough, when it turns negative for two consecutive quarters, that is what we would call a recession.
We can therefore say with the confidence of over 50 years of GDP data, that the business cycle has acted in line with its model and we should therefore experience an expansion in the form of global reopening in the coming months – indicated by the IMF’s dashed forecasted line. Commentators are noting that the economy is “on track for a “V” shaped recovery”, this initial fast paced GDP growth rate, we would argue was due to an overreaction to the potential negative economic impact of COVID 19 on global business.
“You make most of your money in a bear market, you just don’t realise it at the time.” - Shelby Cullom Davis, an American philanthropist and founder of investment management firm Davis Selected Advisers.
During market corrections, you will hear market commentators brandish the term “market volatility” around incessantly. However, we very rarely stop and ask why we fear volatility and what risk it poses to our portfolios.
In our opinion this is a market timing issue directly correlated to the previous statements made around being patient. This has been the highest period of volatility in the US stock market since the Volatility Index’s (VIX) inception in 1999 – the VIX is a real-time market index representing the market's expectations for volatility over the coming 30 days. The US market makes up 57% of the FTSE Global All Cap Index making it a very good indicator of the general trend of global volatility. Therefore, if we have seen the highest so called “risk” to your portfolio in the form of volatility but year to date we hold the same portfolio value, where is the risk?
The risk lies in the behaviour of the investor. Our natural biases tell us to flee danger at the first sign of it and consequently when markets begin to bounce between large daily losses and large daily gains - literally the 3rd worst day and the 10th best day in S&P 500 history - the undisciplined investor wants out due to the uncertainty of where the value of their portfolio may end up. By combining both the behavioural coaching of a financial adviser and a diversified market cap weighted portfolio that captures global returns, we can negate the effects of volatility in the long run.
By coalescing all of the points above, a long-term disciplined investor can sleep easy at night knowing that their hard-earned cash is diversified across a buoyant global economy.
The strong quarter seen by equities and bonds took place as governments pledged unprecedented levels of financial support to temporarily closed businesses and households. Central banks across the world acted to assist with the recovery, introducing a number of policies, including reducing interest rates, in some cases to historically low levels, while also reducing capital requirements for banks in the hope of increasing lending. As lockdown eased, data suggests that some of these policies already seem to be having an effect with signs of a sharp economic rebound. In the US, retail sales increased 17.7% in May, while in the UK the figure was 12.0%.
Although signs of a rebound look promising, the virus has not been fully contained and the difficult task of finding a vaccine remains. The pandemic has disproportionately affected certain countries. Although infection rates have fallen in Europe, parts of Asia and the UK, many countries, especially those in emerging markets, such as India and Brazil, are struggling to contain the spread. The US, perhaps surprisingly as a developed nation, continues to see cases surge. There has been a dislocation between the medical statistics and stock market performance however and US equities returned 20.4% in the quarter while emerging markets returned 18.5%.
The relationship between European and UK equity markets is interesting. After a fairly similar downturn in the first quarter of the year, the UK market lagged in its recovery compared to its European counterparts over the subsequent three months. The UK economy contracted -20.4% in April and although signs suggest the economy will quickly recover once lockdown is lifted, overall the UK is predicted to contract by - 11.5% in 2020 if the virus does not return, or -14.0% if there is a second wave. This compares to global forecasts of -6.0% or -7.6% respectively, highlighting the importance of maintaining a global outlook with regards to investments.
The macro backdrop has been reflected in equity returns. The chart on the following page shows UK equities have suffered, particularly over the 1-year and 3-year return horizons while other markets have recovered more quickly, leaving the UK lagging both over the short and long term. The strong quarter for US stocks extends their outperformance over longer time periods.
Over the short term, bonds have performed comparatively well, supporting our philosophy of diversification to reduce risk by investing across a variety of uncorrelated assets. Global property has suffered considerably and has yet to recover to the extent of other asset classes. This is to be expected as indirect property holdings, such as REITs, tend to fall more quickly and deeply during a downturn.
As economies re-open and the immediate threat from COVID appears to subside, we are likely to see media attention turn to other areas of potential risk. Tensions between China and Western powers over
Hong Kong, the South China Sea and spying have increased in recent months; not only threatening to remove any progress made in relation to the simmering trade war between the US and China but also increasing the chance of tariffs between China and other nations. Brexit is still to be resolved. With little progress being made during the pandemic, the UK government decided not to seek an extension to the transition period by the June 30th deadline, and so the UK will be leaving the EU at the end of the year, with or without a trade agreement. The fast-approaching US Presidential election in November also adds uncertainty. The Democrats appear to lack a strong contender capable of toppling President Trump but with social unrest across the country and Kanye West announcing his intention to run for presidency, well, stranger things have happened!
Rest assured we will not be trying to predict the outcome of any of these scenarios and our portfolios remain positioned for the long term.
Following the rapid equity market correction, portfolio returns over 3 and 5 years are now positive across all models. Portfolio 2 and 3, those with the highest allocation to equities are still in negative territory over the last year, but the gap has closed considerably during the quarter. Naturally, the portfolios with a higher concentration of growth assets were more heavily affected by the downturn and will take longer to recover. This is in line with the reduction in the fixed income allocation and the negative correlation of returns these assets have with equity investments.
Portfolio 3 had a 1-year return of -19.17% to the end of March, which has pulled back to -3.1% at the end of June. This very significant move directly reflects the stock market recovery shown in Figure 1 (page 2) and evidences the benefits of not attempting to time the rebound, instead riding out the market cycle and maintaining exposure. The FTSE Global All Cap index grew by over 6% during the first four days in April - waiting on the side lines trying to predict the recovery while not being invested would have been costly, even for this very short period.
Take a deep breath. We know that this has been a very extreme quarter, for those who are new investors it has been a great lesson and one that you should keep in the memory bank for as long as possible. For those experienced investors, well this has been what you have been preparing for since the last correction in 2008. Nonetheless, if you take anything away from the above reading it should be that disciplined investing will be rewarded in the long term and market corrections are no different to any other time in the market. We do not know what will happen tomorrow, in 6 months, nor ever, and the graphs throughout this commentary should be hung in your home as a reminder to that effect!
We leave you with the words of presidential candidate, Kanye West (did you ever think you would see that in a financial report?).
The risk for me would be in not taking one - that's the only thing that's really risky for me.
Unless specified, all data as at 30th June 2020. Opinions andinformation presented are those of Finalytiq. Capital is at risk. The value andincome received from your investments may go down as well as up and are notguaranteed.”