The primary concern has to be the ability of markets to continue functioning in a worse case scenario.
The Current Situation
The last few weeks of news-flow have been dominated by the spread of the Virus. Investment services now have dedicated news channels to chart the news flow. Expert opinion has been decidedly coming out in the position of “it’s going to get worse before it gets better”.
How the virus story pans out is very difficult to assess. It is on the verge of being classified as a global pandemic and most Countries are declaring emergency situations and putting in place specific protocols to deal with the potential effects.
Financial Market Reaction – Interest Rates
For the financial markets, we have to say that this is firstly a “People” crisis that is developing into a “Financial” crisis. It is impossible to reliably forecast the effect of the virus on economies, markets and individual companies. Central Banks have discussed providing financial support through the mechanisms known as Financial Stimulus; that is the easing of interest rates and the purchase of bonds (QE), tied in with an easing of countercyclical control measures imposed on Banks. This should provide a lot of liquidity to the markets and economies. The problem with this is, when people are ill they do not wish or need to spend any money. This is recognised and Governments are also preparing and providing emergency funding to support individuals and corporations.
The US Federal Reserve has already cut its benchmark interest rate by ½% from 1.6% to 1.1%. It was only in September that this rate stood at 2.40%. This type of rapid easing from the US Federal Reserve is highly unusual, almost unprecedented except in times of crisis – the GFC of 2008/2009 being the last time it occurred.
There is more to come. The Bank of England is expected to follow suit at some point this month – probably at it’s regular meeting on the 26thof March, but maybe before. The financial market is expecting a rate cut with a certainty level of 100%. The US Fed is also expected to make further cuts.
Bond markets have responded to the virus situation by aggressively discounting further rate cuts. 10 year bond yields in the UK have fallen to 0.25%. The US 10 year Treasury stands at 0.75%. These rates have never been lower. Of course, as interest rates fall, their prices rise and at these extreme levels of interest rate, price changes are much greater.
It is expected that 10 year Gilt yields could move into negative yield territory if the news-flow continues to disappoint.
Financial Market Reaction – Equities
Equities have now been marked lower and are in a bear market. We can forget the semantics of what represents a bear market: a correction of 10% or more from a previous high, we just need to focus on the facts that are being presented before us. It is difficult to extrapolate any form of positive outcome for financial markets for quite some time unless and until a vaccine is found or the virus recedes due to immunity or seasonal factors.
Financial Market Reaction – Corporate Bonds
Corporate bonds, which make up part of the allocation of the “Bond” component of investment portfolios have been moving higher in line with Government Bonds. If “Equity” market problems continue, the Corporate Bond market will start to underperform. Corporate bonds also tend to suffer from a factor called “liquidity” or the lack of it – the ability to buy and sell. This liquidity factor deteriorates as volatility rises and as such corporate bonds will begin to underperform.
Financial Market Reaction – Investment Market Functionality
The primary concern has to be the ability of markets to continue functioning in a worse case scenario. Despite the advances of technology, markets still need human intervention to make them work and the human part of the chain requires high and demanding levels of interactive technology. This means it is difficult for financial markets to trade from a series of kitchen tables. All of this is before we even consider the effects on individual Companies that together form the equity and corporate bond markets. We cannot say with any certainty that any business will be unaffected, a few will gain from the situation – Netflix for example. Most Companies will not and previous company forecasts relating to sales & earnings etc will have to be restated. If the market cannot rely on these basic reporting metrics, then uncertainty dictates that stock prices will probably be marked lower until certainty returns.
Our Message to Clients
Our clients have invested into a broadly diversified range of investment portfolios that are managed by some of the most experienced financial management companies in the World.
In addition to this we are thankful that our clients also have in the main part decided on Low or Medium Risk Investment Strategies that maintain high levels of exposure to Bond Markets which act as a counterbalance to moves in equity markets: Bond Yields Fall and their Price Rises. This has helped our portfolios to retain their value and reduced the level of volatility in portfolios.…
However, despite this careful balance, we would still suggest that it is appropriate to reduce investment risk.
As a firm, we have absolute confidence in the ability of Blackrock, Vanguard and Aberdeen Standard Life to manage our client’s investments in almost every circumstance. However, until such time as an antidote or signs of a slowdown in the virus spread is experienced, markets will be exceptionally volatile. Given this unprecedented situation, combined with the global interconnectivity of the modern world in terms of supply chains and financial markets, we feel that we should make clients aware of the risks of being invested. We feel that caution is recommended at this time. We cannot recommend extending investment exposure and would prefer that our clients are protected by moving to a lower level of risk in their investment portfolio or even cash. We may miss a rally in financial markets, for that is the nature of this fast moving situation, but equally we will miss another sell-off.
We cannot be sure what is going to happen and as such we would prefer our clients to be able to retain the value of their wealth, rather than worry about it in an uncertain financial environment.
The commentary has been prepared solely for informational purposes for the recipient, it does not constitute an offer to buy any service, financial product or make any investment or a solicitation of offers to buy any service, financial product or make any investment nor should it be considered as investment advice. Any offers to buy any service, financial product or make an investment or solicitation of offers to buy any service, financial product or make an investment through the provision of investment advice will be made only pursuant to definitive agreements and other documents and information that may be subsequently provided.
Investing or dealing in any financial product should not be considered unless its nature and the extent of the exposure to risk is understood. All investments and financial products involve risk which include (among others) the risk of adverse or unanticipated market, financial or political developments and may include currency risk. Some investments and financial products might carry greater risks than others. Past performance is not a reliable indication of future performance. Investments can go down as well as up and involve the risk of loss.
The commentary is based on information generally available to the public and does not contain any material, non-public information. No representation, warranty or claim is made that it is current, accurate or complete.
SaSo Strategic Advisers Limited is regulated by the Jersey Financial Services Commission for the Conduct of Investment Business.
About the Author
Peter Smart, Head of Investments
01534 488778
Peter has been involved in investment markets since 1985, working within the private client areas of two global banks and for 22 years as the fixed income specialist for the UK Wealth manager, Brewin Dolphin. More recently Peter formed part of the investment team at bridport in Jersey specialising in the provision of specialist, income focussed portfolio’s.