To a man with a hammer, everything looks like a nail.... and to a man who lived through the credit crisis. Every other financial disturbance looks like 2008
We recently opined on the depths of the market in VC7, “Just how far can markets go?”
John Authers, who penned the above quote, without putting any numbers on market levels feels that, despite Government measures to assist the economy and their citizens, that this current crisis will follow the Lehamns crisis, or “GFC” of 2008. Mr Authers has penned an exceptionally revealing piece on Bloomberg, which has now been seen on various websites. Today we reference his thoughts and note that they tie in with our recent conclusions and investment stance.
The rally in equity markets, and sell off in government bonds is understandable, but the extent of the moves, especially in bonds, points to reasons other than the obvious “risk-on” “safety off” routine that has been a feature of our investment landscape for the past decade.
Notwithstanding the underlying reasons for these moves, which are potentially manifold and, to be honest, too obscure for this type of commentary and indeed it’s commentator, the change in heart did not move that part of the market which we highlight as being the “first shoe to drop”.
Despite the rally in equity markets yesterday afternoon, the high yield bond market did not budge. It actually continued its decline. We have touched on this before and it has always been the case, that debt investors are, despite recently accepting loose / declining debt covenant protocols, the most conservative of all. Debt, or Bond investors, from the time they buy a bond can only expect to receive a yield and return of face value. It is this limited return potential that makes them different to others.
At the point of investment, upside, if the bond is held to maturity, is a known quantity, as of course is the downside. The difference between these outcomes is stark; a modest return set against total loss. Right now, bond investors are concerned about total loss. We have not yet witnessed a bond default due to the virus, but it will be coming soon. Mr Authers also makes the point that Bank Equity (on an index basis) did not really make any type of recovery. The link between default losses on bonds and increasing provisions against bad loans in banks is strong.
We remain very concerned and will retain our bias towards cash and security.
Another fascinating and insightful concept from Mr Authers:
The stages of investor sentiment – analogies drawn from “Kubler-Ross stages of grief”:
Denial: the classic initial refusal to believe that anything is different from the last 20 times you successfully bought a little dip
Anger: As losses intensify, phrases like “this market is so stupid” are heard more and more often
Panic: liquidity evaporates, risk premia and volatility soar, and even favorite trades are sacrificed in the name of risk reduction
Response: Policymakers offer up a response to solve the underlying issues, and despite initial hopes markets keep falling...BUT WITH LOWER VOLATILITY
Resignation: When it feels like the terrible trend will go on forever, at last a reversal is in sight [and when all hope is lost, the smallest bit of good news can make people money]
Where are we in this down cycle?
Well, it is difficult to say with certainty, and it depends on what type of investor in the discussion. However, we have moved past stage 1. “Dippers” are still in evidence, but they now believe this time is different. I would also suggest that markets are in “Panic” mode and that 2 and 3 can be combined, probably with the symptoms of “Panic” being expressed sooner than “Anger”. Clearly stage 4 is being enacted before our eyes this week.
Thoughts on stage 5. In 2008, policy makers provided assistance programmes on a continual basis over a period of weeks as markets continued to fall. The truth of the matter now is that assistance has only just started. In 2008, despite continued and novel assistance measures, these had to be continued for a period of five months. Markets started to fret about the Virus around 4 weeks ago. As this is a social / people and real world crisis, measures to assist populations are desperately needed. “Helicopter Money” will happen and I am sure there will be headlines espousing “Helicopter Money, To Rescue Airlines”…
We will build a construct of market, economic and social changes. Conditions that we feel will have to be in place to help guide us back into markets. Our thoughts initially will be around market volatility, credit, financial assistance programmes and the extent of the virus, it will be a constant work in progress.
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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.