Oil Price Collapse & COVID-19 Market Update
Markets are having another poor week as they continue to get themselves into a frenzied state over Covid19. Last week saw unprecedented levels of intra-day volatility in the market as cases continued to spread across Western Europe and America. The following table gives a slight indication as to the unprecedented levels of volatility that we’ve seen:
That volatility is not abating. As I write (Monday 9th, 8:10am) the UK market is having its fourth worst day in history. The primary cause for this is the geo-political games that Russia is trying to play with the United States, inadvertently annoying Saudi Arabia who have retaliated against Russia. Oil, the new international economic weapon. Saudi Arabia were keen to cut production to arrest the declining oil price. Russia didn’t play ball as they wanted to hit the US shale oil industry. Saudi didn’t like this so decided to increase oil production. The result? Oil down 30% over night to $33 and havoc in the equity markets. We’ve seen this all before though, oil can’t fall to $0 a barrel and is likely to find some support at c.$30 a barrel like it did in 2016.
Things are pretty busy today and so I don’t have the luxury of doing a deep dive article in Covid19, but I think the Italians have taken the correct action in isolating the northern part of the country. It worked well in China and it should slow the rise in Italy and other parts of Europe. From a Chinese perspective, we’re actually seeing very few new cases of the virus, which is pleasing, and the economy is starting to pick back up. All good signs, that can get lost in the noise of everything else.
The short-term question remains as to where to deploy capital? Broadly speaking there are four avenues that one can take.
First of all, you could decide to do nothing, which actually is a decision to do something. This would involve not adding any more into equity markets or bond markets and keeping cash on the side-lines. One’s thinking for this is most likely that things are likely to get worse and I’ll be able to buy into the market at far lower levels, thus making more money when the markets rebound. Sounds marvellous in principle but very difficult to do successfully. It’s always very tricky to call the bottom (or top for that matter) of the market. Then what happens if you see a strong rise but think it will still get worse, but things don’t? Investors can end up being out of the market for years, missing good returns, in their quest to invest at the bottom. Research by J.P. Morgan looked at market returns from 1999-2018 and showed the returns achieved on a $10,000 portfolio by investing in the American market:
As can be seen, missing the best days in the market has a profound effect on the value of your investments. Trying to time the bottom of the market can be an expensive mistake if you get it wrong and miss the subsequent bounce.
Secondly, you could decide to invest in lower risk assets such as gold or bonds. You may be of the opinion that things are likely to get worse and so why don’t I buy something that’s negatively correlated to the stock market and does well when markets aren’t performing. That could be a sensible strategy for the short term (but we get into the argument again about how difficult trading the markets is) but I don’t think that is a wise long term investment strategy. Gold is very shiny but has little utility and pays investors no income. It is an asset class that is solely based on capital appreciation (or depreciation) and isn’t a great hedge against inflation. It does well in times of market stress, but markets don’t tend to stay stressed for long. The other option of buying bonds doesn’t seem that sensible either. 10-year gilts currently yield a record low of 0.23%, meaning £10,000 of bonds will deliver you £23 of income per annum. When this is compared to inflation of 1.8% it just seems ludicrous to consider this a sensible long-term investment strategy. One year of inflation eats up nearly 8 years of income.
Anyway, moving onto my preferred strategies. These involve some form of selectively increasing equity exposure in a structured and formulaic way. In my mind you can select two different sorts of equity exposure in the current market conditions. The first way would be to invest on the offense, and purchase sectors that have been directly impacted by Covid19 (Travel and Leisure, Commodities et cetera). Whilst the magnitude of the falls in these sectors has been pretty breath-taking, I don’t think we’ve quite reached peak fear just yet. There will be a point where these will be investable but given the highly uncertain demand outlook for them, I think it is at some point in the future when demand has improved or share prices have continued to fall meaningfully.
The second way to increase equity exposure is to invest in a defensive way and purchase sectors that are unlikely to be impacted by Covid19. Certain sectors such as housebuilders or software companies are unlikely to see any material impact in demand but nonetheless have suffered sharp falls in their share price and could represent good buying opportunities. We tend to favour this approach for our equity exposure at the moment and will look to take advantage of any market volatility.
We’ll be selectively deploying more cash into equity markets over the coming days but will not be aggressive in purchasing equity. This volatility is likely to continue for the coming days and weeks, so we feel it is important to keep hold of some of the cash and lower risk assets that sit within portfolios.
As ever, please feel free to get in touch with your usual advisor if you have any questions.
Chief Investment Officer