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06 Mar 2020

Markets in a Nutshell - COVID-19

Growing fears of a global COVID-19 pandemic dominated markets in February as partial quarantines and severe travel and supply-chain disruptions sapped world growth expectations. Global equities (-8.4% in US dollars) fell precipitously, with the S&P 500 posting its largest single-day decline since 2011. Emerging markets outperformed developed market bourses as Chinese business activity slowly began to normalise after weeks of near-zero activity. Developed market bond yields fell and the US 10-year yield plumbed an all-time low as investors piled into safe-haven assets.

Experts from the Johns Hopkins University Centre for Health Security expect COVID-19 contagion to continue¹ because there is no innate immunity and no vaccine. The global mortality rate is currently 3.4%. Though there is speculation that the ultimate fatality rate will be 1% or less, this will not be known until well after the fact when it’s possible to test the general population for antibodies to the disease in an effort to estimate how many were actually infected (many suffering mild symptoms may have gone undetected and therefore unreported). Although undoubtedly more infectious than previous coronavirus strains, it appears to be not as deadly at this point.

The market is reacting instead to the expected economic impact of travel restrictions, containment, quarantines and disruption to global supply chains and consumer demand. China’s containment actions were severe, with severe economic consequences. But as infection rates in China begin to peak, economic activity should recover in the months ahead.

It is unlikely that the European and US democracies could replicate China’s austere containment measures. The virus should therefore spread more rapidly in these geographies. However, over 80% of patients will probably only suffer mild ‘flu-like symptoms.

So, while COVID-19 will undoubtedly hit global growth this year, in our view there is a low probability of it causing an outright US recession. Nevertheless, a technical recession is still a possibility. The European economy should suffer more given its structural weaknesses.

Central banks are now pledging monetary support with the US Fed already cutting rates by 0.50% on 3 March. This will underpin market sentiment at the same time as exhausting the small amount of emergency firepower left. It’s the rescue boat that keeps on giving. The G7 finance ministry has also pledged to “use all appropriate policy tools” to cushion the effects of the epidemic at its meeting on 3 March. Fiscal expansion might be more successful, but the world is already experiencing record debt levels. We are monitoring these developments closely.

How was Foord prepared for the pandemic? We believe that structuring portfolios for binary outcomes such as war, presidential elections or natural disasters is a high-risk strategy. The key risk is that the high probability outcome does not result, with destructive investment consequences. Optionality and balance are good strategies to manage this risk.

Foord’s fund managers have for some years conservatively positioned the funds against all risks to asset prices. Last year, Foord International Fund’s portfolio managers introduced significant equity protection via S&P 500 put options and short futures contracts. These hedges were extended in January 2020 given the extremely expensive multiples on US equities, based on overly optimistic consensus earnings forecasts. Similarly, the Foord Global Equity Fund has maintained relatively high levels of liquidity in addition to diversifying positions in gold and silver mining companies.

We therefore had no special foresight into the COVID-19 pandemic. The emerging pandemic is just another risk on the matrix that keeps us up at night. Nevertheless, investors were better protected from the resultant panic selling and the portfolios held up reasonably well.

1. Per Dr. Amesh Adalja of Johns Hopkins University Centre for Health Security (as reported by RMB Morgan Stanley)

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