Corona Virus Chronicles (III) - Financial Market Reaction
We have been contacting all of our clients to discuss the market. We are advising clients to undertake a more cautious stance on their investment portfolios and have been helping them to temporarily move into cash by selling some or all of their investments.
Financial Market Reaction
Oil…. Yesterday (9th March) it transpired that, over the weekend, Saudi Arabia acrimoniously cut ties with Russia and decided to increase oil supply. Oil fell more than 30%. Stock markets responded with a broad-based sell-off, centred around the Oil major’s. These were lower by around 20% and second line oil companies which were initially marked down by as much as 70%, eventually closed the day lower by 45%. If Oil stays at these levels – forecasts are for $30 for the rest of this year if Saudi Arabia does not alter course - then we will see this affecting US High Yield Bonds causing further strains on markets. For today we should expect a calmer and more positive day of market movements as the “shorters” reload and look for the next point of entry.
It is very rare to see a total sea of red at such high levels of decline. Our stance of coming out of the markets altogether is backed up by this type of volatility. The culmination of several pieces of bad news affecting the market, when participants are already worried will cause more days like this to come.
The general markdown on most listed companies was between 7% and 10%, whilst trading in the US was temporarily halted as the market plunged 7% on the open, triggering an automatic “limit down” stock trading halt.
The role OF BONDS
Corporate bond spreads are widening as equity market reactions reach ever further into negative territory. Most affected are high risk bonds issued by Oil companies, followed by Subordinated financials – now generically known as Coco’s/T1 issues. Better quality bonds however were much less affected and this sector of the market was assisted by the move to new low yields in Government Bond Markets. (remember, yields down /prices up). The entire German Government Bond market is now in negative yield territory. US Government Bonds breached historic low levels as well, with 10 year Treasuries at 0.65%. UK Gilt yields dropped in tandem, of course. Our benchmark 10 year Gilt resides at a yield of just 0.22%, although at one stage this yield fell to just 0.15%.
This balance of a strong move up in prices for Bonds at the time Equity markets head lower, is marking a turning point. Bonds and Equities, historically, have been held in portfolios to provide a balance to returns. Equities, arguably a more volatile investment segment, provide growth and dividend income. Bonds provide income and a smoother more stable, but lower return than equities. It used to be the case that bond prices, over the medium to long term moved in opposite directions to equity markets. This inverse relationship is called negative correlation. However, over the last few years, the correlation of these markets has been more closely aligned and has been, to a degree, positive as bond rates fell, boosted by QE (prices rise) and Equities also rose for the same reason. At this time, despite bond yields being held at record low levels (which means the risk of bond ownership increases), negative correlation between the two investment groups has been restored. Thankfully the worst effects of the sell-off have been mitigated by the return of this negative correlation relationship.
As Equities have fallen, bond prices have moved strongly ahead, this has definitively helped our clients in our Low Risk and Balanced Models reducing the worst effects of the market turmoil.
Financial Market Reaction – Investment Market Functionality
Continuing with the theme….
We have been contacting all of our clients to discuss the market. We are advising clients to undertake a more cautious stance on their investment portfolios and have been helping them to temporarily move into cash by selling some or all of their investments. In the main part we have been comforted by the fact that the investment models of Blackrock, Vanguard and Aberdeen Standard Life all have dedicated weightings in bonds which have substantially offset equity market volatility and we understand that the investment teams at these Companies who manage our portfolios have made adjustments to add more bonds to these portfolios.
One area in where, to this date, we have seen no portfolio changes is in the Discretionary Portfolio Manager space. We will be looking at the reasoning for this lack of activity. At a time where there are deep and obvious changes taking place we would expect to see more defensive investment strategies being employed to at least protect the gains made over the course of 2019. To us, this is an area of concern. One of the reasons we employ professional investment managers is to provide portfolio guidance at these difficult times. We need to know and understand why they have not adjusted the risk of their portfolios in these circumstances.
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About the Author
Peter Smart, Head of Investments
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.