Picking the bottom of the market is next to impossible, as it depends on so many exogenous and difficult-to-predict factors – such as timing and content of policy decisions, and the progression of the outbreak.
This is why a gradual approach is, in our opinion, the best course of action. Importantly, this is not a market to buy indiscriminately.
In the last three-and-a-half weeks, equity and credit markets have fallen with unusual velocity, not seen since 1987, and sharper even than 1929. While equity drawdowns got the media attention, the US long bond yield moved as much intraweek as in the entire 2013 Taper Tantrum. Dysfunctional markets, wild swings, and a lack of executable bids and offers suggest a liquidity crunch and forced sellers. This is all happening in an environment of large debt overhangs and banks being hampered by regulations and unwillingness to run risk.
All eyes are currently on governments and central banks. They are the ultimate long-term investors, deciding how to support the best economic growth now and in the future. But although historically the toolkit to act has been large, policy flexibility is lower than at any time since the 1950s. You have to be over the age of 80 to know recessions at this starting level of rates (there are advantages in the age of corona to being old…).
At this point, we do not know what the next steps in policy response will be and how deeply and for how long they will affect the global economy. We feel fairly confident that, at some point, markets will recover and recuperate their losses. As long-term equity investors, we have learnt that the best strategy is to slowly and gradually pick our entry points. Picking the bottom is next to impossible, as it depends on so many exogenous and difficult-to-predict factors (such as timing and content of policy decisions and the progression of the outbreak).
This is why a gradual approach is, in our opinion, the best course of action. Importantly, this is not a market to buy indiscriminately. We need to make sure that we are picking the right stocks. In a rebound, the tide will lift all boats, but once the earnings impact becomes clear, we will start being able to distinguish the winners from the losers. Some companies will have more difficulty with recovering; some might never recover.
Companies that face bigger difficulties include those in seasonal businesses such as the fashion industry, where there are short periods for goods to be sold before these become inventory. Another example is companies depending on complex and global supply chains that are facing disruptions. Demand will recover at some point but supply might take longer to fall back into place. Other industries might see a significant and sudden recovery in demand, but the extent of the declines might have made them unable to operate. A case in point is the travel industry. Companies with weak balance sheets and unable to finance their working capital needs might not survive. We are likely to see restructuring and consolidation ahead.
At this stage, we believe that there will be better opportunities to buy in these markets ahead. News of the coronavirus spreading and the related policy response, as well as further strains in the high yield space, could rattle markets further. Earnings estimates will also have to see another round of negative revisions. We are patient. While it is never fun to be in the midst of a market meltdown, we have learned that this is a good time to be long-term active investors.
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