The 23rd of March 2020 will go down in history as the low point of one of the most extreme market crashes of all time. In the three weeks following this day, the corporate bond market became close to dysfunctional and the bid-ask spread on equities widened; this made it expensive to trade, highly volatile, and resulted in most indices falling by over 30%. As with most market dislocations, the correlation between assets increased, resulting in virtually all asset classes declining.
This decline quickly morphed into the fastest bear market in history. All the graphs resembled a cliff edge. Even the most risk-averse portfolios didn’t manage to escape a sharp drawdown at the hand of the coronavirus outbreak:
Our Recovery Strategy
At the start of the crisis, we were moderately overweight to risk assets and were in no way expecting the extent of the COVID crash, having believed Chinese reports and data indicating that the virus was being successfully contained. The usual measures taken by investors to protect the value of their assets against such an occurrence is to hold as diverse a portfolio as possible. In this instance however, almost all asset classes in all markets were impacted by the crash.
Faced with such a severe market environment, we concluded it was futile to try and sell risk assets and attempting to do so would simply lock in losses for clients. Instead, we held our nerve and began to build up cash positions from assets that had fared better such as bonds, gilts and gold, in preparation for the rally that we believed would come. As the market regained its poise, we rebalanced into equity and were rewarded as momentum began to push risk assets higher.
In the two months following the crash, markets staged an impressive rebound with the S&P500 gaining 35%. Our strategies and investment portfolios also recovered strongly initially, with our balanced strategy gaining some 7-8%.
The recovery in markets was spurred by the actions of global central banks and led by the Federal Reserve which committed to unlimited and open-ended QE with the inclusion of high yield bond purchases for the first time. This was unprecedented monetary stimulus with the aim of feeding the economy in the difficult year that lay ahead.
As we moved into the third quarter, markets continued to perform well and although the fourth quarter saw the reintroduction of lockdowns more severe than the last, in November we witnessed the best month for stock markets since 1987 as confidence returned to energy, financials and other pandemic losers.
In early December, the vaccine rollout began and transformed the tone and sentiment in the markets. After nine months of extreme market movements that reflected the latest news on the pandemic, markets began to steady and look ahead to the spring.
How have our portfolios fared?
If we look at our balanced sterling portfolio, we can see that it has staged a strong recovery in the year since the crash and is now outperforming its peer group indices:
Our institutional Sovereign H4 portfolio is also performing well compared with its peer group:
This positive performance is a result of being slightly overweight equities and underweight bonds against our benchmark. In addition, within our equity strategy, our portfolio exposure in each region has outperformed its relevant benchmark; we attribute this to our decision to be invested in more value-orientated and slightly more cyclical stocks.
The table below highlights two traditional measures of valuation; price to earnings (P/E) and price to book ratio (P/B), where we have taken a meaningfully more value-orientated position than the indexes. The performances shown are from end of July 2020 to the end of February 2021:
Emerging from the Pandemic
As the vaccine rollout continues and life looks to potentially be returning to some form of normality, in the near term, our strategy will be to target developed markets. We also believe that our value strategy has further yet to run, while our cyclicals strategy has potentially run its course.
We are positioned for and see interest rates moving out further. We expect the US 10-year treasuries & gilts could be yielding 2% and 1.4% respectively before year end. The rationale for this is that we see inflation running slightly higher than policy makers. Credit spreads should offer some buffer to this; we expect them to tighten slightly if economic conditions remain favourable. Finally, although Sterling has been strong, we may see some weakness going forward as both dollar yields attract some investors and sterling loses some relative global attractiveness on a carry basis.