Investment Clock insights

Navigating the Coronavirus crisis


Trevor Greetham

6 March 2020

The emergence of a new and deadly virus poses special challenges to society, to businesses and to financial markets. Our disciplined and rigorous investment process provides a strong framework for responding to a crisis, controlling risk and positioning portfolios for active management opportunities that arise. We are assessing the outbreak on the basis of guiding principles that we will refresh and update as new information comes in.

1. We expect a short but deep shock to the world economy caused by reversible containment measures intended to slow the spread of the virus. There are parallels with previous geopolitical shocks such as the 9/11 terrorist attacks and the Iraq War which created sudden but short-lived contractions in activity.

2. Political pressure to shutter parts of the economy will rise as case numbers increase and this will cause a drop in economic activity. Later, political pressure to re-open the economy will build up as incomes drop, companies fail and credit stresses rise (chart  1).
 
3. Re-opening the economy will result in a sudden rebound in economic activity. Our base case is that it will be 3-6 months before we reach this point but there is significant uncertainty and some economies will re-open earlier (China?) and others later (USA?).
 
4. There are a wide range of possible outcomes from a mild shock (“V-shaped”), to a moderate and temporary downturn (“U-shaped”) to a recession (“L-shaped”) with second round credit effects caused by the cutting off of corporate cash flow.
 
5. As a result, volatility could remain elevated for months with bouts of selling followed by sudden rebounds. Markets tend to over-discount bad news in the short term and this will create opportunities for active investors willing to buy the dips and sell the rallies.
 
6. The low inflation backdrop and low level of government bond yields are supportive of monetary and fiscal ease and this ease won’t be removed quickly for fear of a further wave of infections later in the year. 
 
7. The shock is ultimately temporary and in its aftermath growth will be stronger than otherwise due to pent up spending, the positive effect of additional stimulus and the need to rebuild depleted inventories caused by factory closures. We don’t want to be defensively positioned at this time.


Chart 1: Schematic diagram for pressure to close and later re-open the economy

Before the crisis hit we saw signs of an upturn in global growth in response to widespread monetary ease over 2019 and we had a large overweight position in stocks. We expect our Investment Clock business cycle model to swing dramatically in response to the crisis as growth indicators weaken and later rebound strongly given the additional fiscal and monetary stimulus we will see during this period (chart 2). Our intention is to come out of the crisis with a large overweight in stocks when the time is right but to demonstrate sensible risk control in the meantime.

Chart 2: Investment Clock diagram with coronavirus impact projection

 

The volatility capping process designed to limit downside risk in our Multi Asset Strategies Fund is starting to come into force. However, volatility can also create opportunities. RLAM’s Composite Sentiment Indicator registered one of its ten most panicked readings this week (table 1), more than three standard deviations below average (chart 3). It usually pays to buy when others are fearful. We used our tactical asset allocation risk budget to add to equity exposure, selling again during the subsequent sharp rebound.

Table 1: Top Ten Investor Panics since 1990


Chart 3: RLAM Composite Investor Sentiment Indicator with Stock Prices

 

Note:  RLAM Composite Sentiment Indicator is based on market returns, volatility, private investor bullishness and company director dealing in the stock of their own companies

 

We expect the outlook to remain highly uncertain for the next few months and we will continue to monitor the situation closely and adapt our portfolios accordingly. If the situation deteriorates we know from our experience during the Great Financial Crisis that our investment process is flexible enough to move us gradually into more defensive assets and limit downside risk until the crisis comes to an end. In the longer term scheme of things, we expect the coronavirus shock to be a temporary interruption in an extended period of low inflation, positive economic growth and rising stock prices.

 

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.

 

 

The emergence of a new and deadly virus poses special challenges to society, to businesses and to financial markets. Our disciplined and rigorous investment process provides a strong framework for responding to a crisis, controlling risk and positioning portfolios for active management opportunities that arise. We are assessing the outbreak on the basis of guiding principles that we will refresh and update as new information comes in.

 

1.      We expect a short but deep shock to the world economy caused by reversible containment measures intended to slow the spread of the virus. There are parallels with previous geopolitical shocks such as the 9/11 terrorist attacks and the Iraq War which created sudden but short-lived contractions in activity.

 

2.      Political pressure to shutter parts of the economy will rise as case numbers increase and this will cause a drop in economic activity. Later, political pressure to re-open the economy will build up as incomes drop, companies fail and credit stresses rise (chart  1).

 

3.      Re-opening the economy will result in a sudden rebound in economic activity. Our base case is that it will be 3-6 months before we reach this point but there is significant uncertainty and some economies will re-open earlier (China?) and others later (USA?).

 

4.      There are a wide range of possible outcomes from a mild shock (“V-shaped”), to a moderate and temporary downturn (“U-shaped”) to a recession (“L-shaped”) with second round credit effects caused by the cutting off of corporate cash flow.

 

5.      As a result, volatility could remain elevated for months with bouts of selling followed by sudden rebounds. Markets tend to over-discount bad news in the short term and this will create opportunities for active investors willing to buy the dips and sell the rallies.

 

6.      The low inflation backdrop and low level of government bond yields are supportive of monetary and fiscal ease and this ease won’t be removed quickly for fear of a further wave of infections later in the year. 

 

7.      The shock is ultimately temporary and in its aftermath growth will be stronger than otherwise due to pent up spending, the positive effect of additional stimulus and the need to rebuild depleted inventories caused by factory closures. We don’t want to be defensively positioned at this time.

 

Chart 1: Schematic diagram for pressure to close and later re-open the econom