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. 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. The first confirmed case in South Africa was reported on 5 March. With the South African economy already in a technical recession, this is not good news given the additional drag on economic activity that will likely result.
Globally, 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. Whilst the SARB might have some monetary policy wiggle room, it is unlikely that we will see significant interest rate cuts in South Africa given the reliance on foreign portfolio flows to fund our meaningful current account deficit. 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 SA and global portfolios 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.
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.
In South Africa, the FTSE/JSE Capped All Share Index (-9.5% in rands) tracked global bourses lower as South Africa’s structural headwinds and looming Moody’s rating review compounded the prevailing risk-off sentiment. Global events completely overshadowed the annual budget speech, which again revealed very troubled public finances and government’s high-risk cost containment response.
A reduction in the public-sector wage bill is undoubtedly critical, but will be extremely difficult to implement given the prevailing political constraints. We nonetheless commend Tito Mboweni’s intentions and believe he is the right person for the job, given his relative independence in the party machinery. If we see him resigning, we will know he has failed.
The All Bond Index finished flat with the portfolio’s core holding in short to medium-term government bonds providing meaningful capital protection. The low weight to listed property also protected investors given the sector’s very weak operating environment. The full allocation to foreign assets (where allowed) was positive with the much weaker rand offering some protection to South African investors.
1. Per Dr. Amesh Adalja of Johns Hopkins University Centre for Health Security (as reported by RMB Morgan Stanley)