The Second Wave
Where should we begin? The rhetorical question begs a response of ‘at the beginning’; the problem is that we do not know where that is. We have moved with extraordinary speed from reading stories of a new form of pneumonia in a part of China probably few of us had heard of, to the suspension of daily life as we know it. It is bewildering. It is therefore no surprise that investment markets are indeed bewildered. So let us try to make sense of what is happening and what may come about as 2020 progresses.
This valiant quest comes with a significant opening caveat. Knowing the speed with which the facts can change, it is highly likely that the short space of time between the writing of this article and its arrival into your email, or its thump upon your doormat, will have diminished its relevance. Unfortunately that cannot be helped.
Only time will tell if the near global acceptance of the concept of ‘lockdown’ was the right thing to do. The experience of the early adopters – notably China – is that it can, at least temporarily, inhibit the spread of the coronavirus. It is also causing terrible economic damage. It is extremely difficult to try to put both of these into a mathematical equation. To do so would risk putting a monetary value against a life. We all hope, of course, that lockdown is indeed saving many, many lives. It has also placed an icy grip on the economies of most of the world.
Lockdown has placed an icy grip on the economies of most of the world
Everything depends on the progress of the coronavirus. In the shorter-term, we all know how the disease will progress in Europe, the United States and elsewhere. That is not up for debate. The issue is what happens in China as it tries to return to a more normal state of affairs. On the one hand, this may be a relatively smooth process, without a second wave of infections. On the other, it may be the snake that takes us back to square one. It is this threat of a second wave of the virus that will determine both our daily lives and the direction of investment markets.
In the absence of this second wave, there are good grounds for a degree of optimism. Isolation will come to an end and businesses will, tentatively, restart. Share prices will rise; not back to January’s levels, but certainly higher than at present. Bond yields will also rise (meaning that prices fall); again, this is unlikely to be by much, but it will be noticeable. The central banks will be able to rein back on their promises of unlimited money-printing and we shall all nervously climb back onto the horse that had so dramatically ejected us from our saddle.
A second round of infections, in contrast, would take us down a very dark road. Lockdowns would be extended, or reintroduced, and the economic damage multiplied. We would also reason that the world’s patience for enforced isolation and widespread financial ruin would pretty quickly run thin. The likely response to that would be the deployment of troops and martial laws. These are roads none of us would wish to be on. It is more likely that the virus would be left to run its natural course.
The response by the world’s central banks has been genuinely impressive. Lessons have been learned from the mistakes of the Great Financial Crisis. First, the balance sheets of the retail and commercial banks are much stronger than at any time in the previous 10-15 years. Second, these banks are now being encouraged to expand their balance sheets, rather than the disastrous enforced shrinking of them that so exaggerated the post-Crisis recession. Third, the central banks have let it be known that they will make unlimited finance available, should it be needed. This is crucial: the banks need to have the confidence that they all have access to ready money. That way, the credit markets continue to function – in complete contrast to 2007/08. Without the Great Financial Crisis, we may not have been in a position to survive the lockdown.
Even on an assumption of a best case outcome, we should not expect equity markets to return to their pre-virus levels in the near term. We had long argued that those heights were justifiable if the global economy remained benignly dull, with low and steady inflation and growth. That assumption has been firmly torpedoed. The policy response to the virus (note it is governments’ policy, not the virus itself) has reintroduced a hugely volatile and uncertain economic cycle. This in turn will dictate a lower valuation for equities than we have seen for a while.
The response by the world’s central banks has been genuinely impressive
Then we have to consider the unknown risks of the simply extraordinary amounts of money that the central banks have promised. Yes, these have very successfully greased the economic cogs in the short-term, but at what risk? Will this finally bring about the return to inflation that so many have feared for so long? Of course none of us knows, but it is a new and additional risk in the post-virus world.
The valuation of your portfolio that accompanies this newsletter will doubtless deliver mixed news. The prices of many assets have fallen substantially since the turn of the year, but we have also taken decisive action to try to protect the value of your investments. There have been notable safe havens – gold and sovereign bonds stand out – while the fall in sterling has been a welcome boost to our investments outside the UK. We have tried to focus our equity holdings on companies with proven resilience and strong balance sheets: those best placed to ride out a temporary unprecedented drop in sales.
There is a greater challenge in maintaining income. Many companies have cut or even passed their normal dividend payments as they protect their own ability to pay their bills whilst sales are so low. This is also true of many real estate investment trusts, which have tenants temporarily unable to pay rents. It is our natural hope that this will prove to be a relatively short-lived phenomenon, but we cannot escape the reality that providing income from portfolios will be uniquely challenging this year.
The virus will change the world, even if we recover quickly. It has exposed fragilities in business models that neither we, nor others, could have appreciated. Whether for good or bad, we will rely even more on technology versus the physical. Technology’s fragility in turn is its reliance on electric power, meaning an even greater need for reliable and arguably renewable sources of this. The virus will also bring a greater appreciation of the virtues of local sourcing, of goods, services and food.
We come to the possibly unsatisfactory conclusion that there is a world and life beyond the coronavirus. We just do not know how long it will take to get there, nor how bumpy the road is that takes us there. Hawksmoor has always been a cautious and prudent investor; we will continue to balance the need to protect the values of our clients’ investments with the opportunities that always arise with such severe market disruptions.
Jim Wood-Smith – Chief Investment Officer, Private Clients
Before the Virus
It is possibly hard to remember, but there was a time before the virus took over the world. This short article will hopefully serve as a reminder of a selection of what else there is that matters to the investment world.
The US Presidential Election
Joe Biden has taken a decisive lead in the Democrat primaries. This was calming markets that viewed him as less radical than Bernie Sanders, the early leader, and less likely to defeat Trump. The view of the market was simplistic in the extreme: Trump good, Democrat bad. We, nor anyone else, now knows whether or how the virus will affect the timing of the election. The US electoral cycle and the timing of the election of the president are set by the Constitution and are very awkward to change. What will happen if lockdown restrictions continue until much later in the year will be a major issue.
The UK Budget
On March 11th, Rishi Sunak delivered what would ordinarily have been a revolutionary budget. The current Conservative government was embarking a radical policy of ‘borrow and spend’, based on a belief that the extreme low cost of debt (10 year gilt yields of less than half of one percent) would permit a huge expansion of the budget deficit. Money is cheap, and it would be spent on roads, rail and broadband. Free from the European Union, Boris Johnson’s government was to attempt policies to achieve higher economic growth.
As with the US elections, we do not know how Covid-19 will affect the timing of Brexit. If we believe that the deadlines will not change, then the chances of achieving a trade deal by the year end have diminished even further. Prior to the virus, the government’s stance was appearing to be becoming increasingly ‘hard’. This was to the extent that No Deal had been rebranded as an ‘Australian-style deal’, signalling that this was probably what was intended. That remains the most likely outcome.
The Australian fires were national headlines for weeks. The challenges posed by climate change were very much at the forefront of popular awareness and the willingness to try to understand the importance of decarbonization was gathering an impressive momentum. The share prices of companies helping that process were leading stock markets (and arguably still do). It is possible that the post-virus rebuilding of economies will see a step change upwards in sustainability, but we cannot ignore the risk that many will take the easy route of using what is now very cheap oil.
James Clark – Senior Fund Analyst
A Message From Sarah Soar, Hawksmoor’s New Chief Executive
Over the last few months I have been asked by many people, “Why are you joining Hawksmoor?” and the answer has always been very simple: I was immediately attracted by the very strong core values and culture demonstrated throughout the organisation. It is in times of crisis that values are laid bare and true integrity is put in the spotlight and no more so than now, as we experience one of the greatest challenges in modern history-the Coronavirus pandemic.
I have never felt more proud to be part of such a remarkable team. They have pulled together in recent days to ensure that we can continue to provide the same level of high quality service to our clients whilst our infrastructure was changing so quickly. As the severity of the situation unfolded, the speed of adjustment increased and it was a great relief to know that all my colleagues were working safely from home when the lockdown was announced.
In addition to a rapidly changed working environment, we have also had the challenge of global financial markets crashing at unprecedented speed and magnitude, testing the nerves of even the most experienced fund and investment managers. Here again, the quality of the team has shone through as we have focussed on ensuring your portfolios are correctly positioned, and that can continue to deliver on your particular mandate with the support of our talented research team.
We have just entered a period of extreme uncertainty and none of us knows when or where it will end, but one thing we do know is that it will end. We don’t know what the world will look like economically or otherwise once this pandemic has passed, but it will undoubtedly be very different. What, however, will not change is our unwavering desire to look after our clients and their investments to the very best of our ability in the months and years to come.
In these difficult times, with all our staff working from home, we have had to send the quarterly reports without the usual covering letters. Do please feel free to contact your investment manager if you have any queries, they are all working from home but contactable through the normal ways.
With very best wishes to you and your family in these worrying times.
Sarah Soar – Chief Executive Officer
Hawksmoor Investment Management Limited is authorised and regulated by the Financial Conduct Authority (www.fca.org.uk) with its registered office at 2nd Floor Stratus House, Emperor Way, Exeter Business Park, Exeter, Devon EX1 3QS. This document does not constitute an offer or invitation to any person in respect of the securities or funds described, nor should its content be interpreted as investment or tax advice for which you should consult your independent financial adviser and or accountant. The information and opinions it contains have been compiled or arrived at from sources believed to be reliable at the time and are given in good faith, but no representation is made as to their accuracy, completeness or correctness. The information and opinions expressed in this document, whether in general or both on the performance of individual securities and in a wider economic context, represent the views of Hawksmoor at the time of preparation and may be subject to change. Past performance is not a guide to future performance. The value of an investment and any income from it can fall as well as rise as a result of market and currency fluctuations. You may not get back the amount you originally invested.