“Panic is highly contagious, especially in situations when nothing is known and everything is in flux.” – Stephen King
Stock markets across the world had their worst day since the 2008 financial crisis on 9 March this year. A more than 30% intra-day crash in the oil price added further volatility to a market already spooked by the potential impact of Covid-19 on global economic growth. These events also triggered a 7.6% collapse in the S&P 500 Index and a weakening of the rand by 2% by end of trade on Monday. In light of this extraordinary cocktail of events, we deemed it essential that we share our insights surrounding this year’s sharp equity sell-off, as well as how we are positioning our clients for resulting market turmoil.
The economic and health contexts
At a time when many economists only anticipated a slowdown in economic growth worldwide, there is now a real possibility that the coronavirus and oil price crash could induce a global recession. The extent and duration of the economic impact is still hard to predict, but companies in sectors such as transport, tourism, catering, automotive, information technology, resources, financial services and manufacturing are all at risk from the fallout. Indeed, there are very few sectors that have not as yet been negatively affected by responses to the virus from government, business and the global population at large.
The coronavirus has dented economic growth in China, disrupted global supply chains, forced the cancellation of many major public events, and caused many business travellers and tourists to put travel plans on hold.
As is generally the case when the economic outlook is clouded by uncertainty, investors are fleeing towards safe havens like US Treasury Bonds and gold, and away from riskier bets like emerging-market assets and stocks. The result is that equity markets have sold off sharply and are likely to remain volatile for a while yet.
Meanwhile, from a health perspective, it is most interesting to note how preventative measures, which may be very effective in containing the spread of the virus (such as regional quarantines, travel embargoes, and temporary business closures), are also responsible in the shorter term for exacerbating the economic meltdown!
To effectively fight the Coronavirus pandemic, whilst simultaneously mitigating the risk of potential systemic economic failure, collaboration between economists, policymakers and medical practitioners will be essential. This is aptly summarised by Barry Eichengreen, Professor of Economics at the University of California, Berkeley, who states: ‘In the fight against the Covid-19 pandemic… economists, economic policymakers, and bodies like the G7 should humbly acknowledge that ‘’all appropriate tools” imply, above all, those wielded by medical practitioners and epidemiologists. Co-ordination, autonomy, and transparency must be the watchwords.’
How has this affected our clients so far?
We have been positioning our clients’ portfolios for the risk of a global slowdown for some time. As a result, our proprietary funds and selected building blocks have fared well on a relative basis when compared against general market conditions. This is illustrated in the table below, which shows performance year-to-date until the close of markets on 9 March, as well as performances for the 2019 calendar year:
We have implemented a defensive strategy in our funds – apart from index trackers – with a bias towards quality companies in defensive sectors with predictable earnings streams. Our portfolios are therefore currently light on stocks in energy and banking, the sectors that took the most pain as the market went into freefall on Monday.
In our Global Preserver Fund, we have been increasing our cash holdings since February, and our equity exposure currently stands at 34.5%, down from 43% in November 2019. Our most conservatively positioned Fund, Rubrics, has held up well on an absolute basis and has provided accumulative cash-beating return since January 2019.
In our local portfolios, we continue to maintain maximum offshore exposure within regulatory guidelines. This positioning has helped to cushion our rand-based investors from the JSE’s appalling performance, which was down 25% as measured in USD for the year-to-date by end of trade on Monday.
We have introduced a currency hedge on a portion of our offshore exposure in both our proprietary domestic funds and will increase this position should the rand weaken significantly from current levels. In our domestic Dynasty Wealth Preserver Fund, we have used a historically wide yield gap (compared to US 10-year treasuries) to introduce SA bonds of longer duration into the portfolio.
What does this mean for the future investment horizon?
For the team at Dynasty, this is not the first market crash we have experienced, nor do we expect it to be the last. We have steered clients through events such as Black October in 1987, the emerging market crisis of 1998, the dotcom bust of 2001, and more recently, the Global Financial Crisis of 2008.
The lesson from each of these market corrections is that equity markets invariably recover, although it is more a function of luck to predict exactly when a bear market will find its bottom or when the recovery will begin. In practical terms, this means that investors who stick to a rational, long-term investment strategy, will generally be well-positioned to weather the storm.
For context, we paint a worst-case scenario going back to the Global Financial Crisis when the S&P 500 troughed in Q1 2009: had an investor suffered the misfortune of commencing investment in this index in October 2007 (this being at the very peak of the previous bull market cycle), the investment would nonetheless have yielded a dollar return of 6.8% per annum up to, and including 9 March 2020, this being very substantially ahead of USD cash over the same period!
For other pointers as to what may lie in store for investors over shorter-term time horizons, the performance profile of global equity markets following the 2003 SARS epidemic is depicted in the table below:
With due consideration to the Dynasty Investment Committee’s empirical research, our strategic approach for different categories of clients is summarised below:
- Equity investors – remain fully invested.
- Offshore investors sitting on disproportionately large cash holdings/awaiting a correction in global equity markets – we propose a phase-in approach to buying equities by investing up to one-third of the designated exposure immediately.
- Domestic investors seeking to remit funds offshore – we are not remitting funds at current exchange rate levels but will monitor developments closely.
- Domestic investors with an appetite for risk – increase exposure to our domestic Dynasty Wealth Accumulator Fund. We believe risk-on sentiment should return as the coronavirus recedes. Additionally, a sharply weaker oil price should be net positive for South Africa. (However, on a longer-term view, we maintain our conviction that far superior investment opportunities can be accessed outside of South Africa, and that the domestic economy remains structurally weak).
Panic can be as contagious as a virus. But rather than panicking, astute investors should avoid the cognitive biases of either panic or denial. Rather, market corrections present opportunities which can be exploited to build wealth over the longer term. Our advice, as always, is to look beyond market noise and to focus on logic and fundamentals which ultimately follow the unknowns. In summary, coronavirus and the oil price war are not as yet indicative of any sustained systemic failure such as the breakdown in the banking system that caused the Global Financial Crisis.
Finally, clients who have consistently followed our advice have been handsomely rewarded over the longer-term by way of wealth creation, the extent of which always has been subject to their individual risk tolerances.
Article compiled by Barry Dubb and Ryan Page
Other useful articles to reference include:
- Money Marketing: COVID-19: its impact on economies and financial markets.
- Daily Maverick: Stock markets tank as oil joins a toxic economic mix