June 2020

Investment & Wealth Advice

The impact of Covid-19

Prompted by the limitations imposed by lockdown we have created a series of digital events which allow our clients to join a live talk given by one of our investment and wealth advice team members.   This is a written summary of our first in the series which featured John Butters, Chief Investment Officer (JB) and Quentin Marshall, Head of the Private Bank (QM) who discussed the current investment climate in the wake of Covid-19 and recent market turbulance.  In the future we will also be recording these events and making them available to watch from our website.

A Covid-19 Backdrop

Our understanding of the impact of Covid-19 and variations between countries is still shifting.  Studies currently estimate the fatality rate at 0.5%-1% of cases although this might well be revised downwards.  In global terms, the UK’s 615 deaths per million of population is high. This may be due to our high density of population by contrast with our European neighbours, particularly in cities, our level of smoking and the UK’s function as a transport hub.  
The USA is clearly crucial for global markets and continues to be badly hit by Covid-19.  However, other countries’ experience provides a good guide to what might happen next, and it is encouraging to see the success of the test and trace system in South Korea and Taiwan.  
The UK’s test and trace regime is starting to ramp up with thousands of tracers hired by the government. The UK now comes third in terms of the total number of swab tests carried out, giving grounds for optimism.  Globally, an assortment of different tactics has been used and, overall, the picture is that Covid-19 is coming under control.

QM - How do we see the economic impact of Covid-19

JB - At a high level, it’s still hard to tell how badly the world economy will be affected.  GDP statistics are only available for the first quarter of 2020; these show UK GDP dropping by 2% as we began to feel the effects of the slowdown, by contrast with China’s 9% drop in GDP in the first quarter when Covid-19 was at a peak there.  For the UK and much of the developed world, the main impact will be in Q2.
JB - Given the delays to published GDP figures we tend to resort to other economic indicators.  We know that London traffic has decreased by over 70%, but in jurisdictions like Paris, where lockdown is beginning to be relaxed, we can see traffic activity building up again after a steep drop.  UK retail activity has seen a 67% drop in footfall, by comparison with a 19% reduction in the US where the lockdown has been less stringent.  The UK has not, to date, seen a big rise in unemployment, but the true position is only likely to emerge once the furlough scheme is wound down.  Anecdotally, companies are cutting costs and so it is likely that more jobs will go.  Looking at the USA, which has not had an equivalent paid furlough scheme, unemployment now stands at over 13%.

QM - Where does this leave economic forecasts?

JB - As the stopping of the world economy is unprecedented, there is no past experience on which to base views about the speed of recovery.  Attempts to predict where the UK economy heads from here are largely guesswork.  A prediction from Capital Economics indicated a 12% total decline in 2020.  This, however, was made up of a much deeper initial decline followed by a reversal of the drop. If this proves right we may therefore have seen the worst already.  Most forecasters expect a bounceback in 2021 so one could say that the best guesses indicate a strong recovery.

QM – How has Government policy affected the economic outlook?

JB - Clearly government intervention has been on a huge scale.  There is a political angle to the question of how long lockdown or partial lockdown can continue.  Research has been undertaken on what people would be prepared to pay for one ‘quality adjusted year of life’ in order to assess the benefits of lockdown.  The NHS will generally approve £20-30k for one quality adjusted year of life and the costs of sustaining lockdown are now running at some £75k.  Arguably, therefore, we are now past the stage where the benefits of lockdown exceed the politically acceptable cost of improving health outcomes.
JB – The stay at home and protect the NHS strategy has broadly worked in that the NHS does have capacity to treat people.  So, in balancing the political and economic fallout, the best guess is that we will move towards local lockdowns as clusters of infection resurface.  Indeed this seems to be happening in Beijing at the moment.

QM – How will this affect Government economic policy?

JB - An obvious question is whether a further period of austerity will be required in order to pay for the recent largesse.  Arguably, this should not be necessary as the government can borrow at close to 0%. Taking inflation into account as well, the real borrowing cost is actually negative, so there would be a strong argument for rolling over the borrowings.
JB - Looking across the pond for corroboration, the Federal Reserve has also made huge interventions, cutting interest rates and buying up financial assets indicating a quasi-Quantative Easing (QE) programme.   Effectively Central Banks are stepping in to ensure that markets can function.  Overall we can expect governments to be less fearful of spending money financed by central banks, an approach which would look very similar to QE.
JB - Inflation is a concern that’s been raised by many, but with likely unemployment levels driving demand lower, this crisis seems to be deflationary rather than inflationary.  Provided that central banks are prepared to act if necessary, inflation should remain under control.

QM - How are financial markets coping?

JB - It’s clear that the UK has suffered more than most, possibly due to the predominance of oil stocks within the UKFTSE and, unlike the US, the absence of major tech stocks.  At the beginning of the crisis we saw share values plummet, but they have since recovered much of the lost ground. This is expected market behaviour - markets bottom out when things look darkest.  Thus in 1940, the stock market hit the bottom at the time of the Dunkirk rescue, even though victory was far from assured at that point.  Similarly, in 2009, stocks started to recover when Ben Bernanke claimed to see ‘green shoots’ of recovery.  The markets accepted this, and by the end of 2009 stocks had recovered to pre-crash levels.

QM – How have investment managers performed?

JB – UK investment managers’ performance has probably suffered from the natural UK bias and from attempts to time the market.  Weatherbys’ favoured managers, Sarasin and Hambro, have done better than most and Sarasin in particular had made some good market calls.
JB - on market timing we should be sceptical about active investment managers’ claims.  Even those with the best information – Central Banks, governments and economists – are unable to predict the economy accurately, so there is no reason to believe that investment managers can either.  Stock picking successfully imposes another layer on top, requiring the manager to be right about a company when everyone else is wrong.  In practice this rarely happens.

QM – So should anyone long in cash enter the markets now?

JB – Given the reality that nobody really knows what will happen within markets, , the approach most likely to succeed is to assess one’s risk comfort level, form a long-term strategy and then stick with it.  One can test it to get reassurance that the strategy will survive market ups and downs, but over time equities have yielded better results than any asset class indicating a long-term buy and hold approach.
JB – That doesn’t necessarily mean that we should invest a significant portion of our wealth in the stock market as a lump.  In reality we all make decisions based on emotions.  Emotions are not generally a good guide to financial decision-making, but a disciplined approach can help keep impulses under control and support the long-term strategy.  So, to avoid regrets about market timing, behaviour management may indicate drip feeding funds into the market. This may result in missing some time in the market but at least ensures a systematic approach.

QM – Have your views changed during the crisis?

JB – No, the overarching view was unchanged and in accordance with the Weatherbys’ house view. This meant that, for those who wanted actively managed investments, we would choose high quality investment managers based on our own research and investigations. Our favourite approach, however, would be to use a tracking system.  This, too, requires some decision-making so, for example, we need to decide what sort of funds to buy as part of the tracking package. In general we avoid ultra low yields but we also want to ensure that any bonds held are negatively correlated with equities.  As the generally low yields approach zero, this presents a problem for our portfolio construction.  If yields cannot reduce below zero, then that would cap bond prices and their ability to provide cover for equities in bad times.  As a result, we have had to factor the yield floor into our portfolios.

QM – Did you expect the Bank of England to implement negative interest rates?

JB – Not until recently.  Now it was harder to call.  Looking around the globe, based on the Japanese experience, a small negative rate was possible. However, the Japanese economy has major differences from the UK which may invalidate comparisons.  Negative interest rates would have an adverse effect on the banking system. Banks would be unable to “pay“ negative rates which would make the business of borrowing and lending very difficult. Politically it seems unfortunate to inflict pain on the banks now as it would prevent them from being able to lend and lending will be required to reignite the post Covid-19 economy.

QM – Many clients hold property for long term growth; will investors continue to buy?

JB  - One cannot make forecasts on the property market but a concern is whether the success of working from home during lockdown has changed working patterns for ever such that there would be an oversupply of office space in city centres with adverse impacts for commercial landlords.  It’s not clear how sustainable working from home will be on a long-term basis.  Aspects of home working are hard and it seems unlikely that it will ever substitute fully for working within a commercial hub and doing business face to face.
JB – In terms of portfolio construction, there remain attractions to use of real estate as part of an asset portfolio; it has the advantage of being able to borrow against the real estate and, as one cannot see the price move around on a day to day basis, it may be psychologically easier to cope with market volatility than holding stocks.

QM - What about Brexit?

JB – Countries tend to trade with those nearby and research indicates that the potential tariffs and import delays would have a fairly minor impact.  For investors, the falls in sterling associated with Brexit have been extremely profitable.  The political and media impact is likely to be greater emotionally than it will be on the markets as the markets are interested in corporate profits rather than political decisions.
JB - The best guide to prospects for an EU deal was the incentives driving each side.  The EU has an incentive to maintain the integrity of the Single Market, but overall a deal seemed likely, probably at the last minute.

QM – What are your views on alternative assets? (gold/crypto/ESG)

JB – Sceptical on gold as it does not fit our portfolio approach of building economic stakes in government and corporate income.  Gold has done well since the financial crash on the back of falling interest rates.  Assuming a zero cap on yields, that effect must have limitations.
JB – Crypto currencies are pure speculation based on limited supply.  Given that one can use any token as money, it’s hard to justify the use case for crypto currencies.
JB – ESG is difficult in that the boundaries are unclear – for example, would an ESG approach preclude Chinese investment based on their carbon footprint?

QM - What is the likely impact of a second wave of infection?

JB - In the UK this would be largely dependent on the success of the test and trace system.  The prospects for dealing with the next wave of Covid-19 using vaccines and treatments seem overdone. Vaccines take a long time to develop: the Ebola vaccine was the fastest and that took some five years.  Developing a cure would require huge investment from the pharmaceutical companies, although it is encouraging to see early success with a steroid treatment for the most severe cases.  Test and trace is therefore our best option.
JB - The impact of any second wave on markets would depend on action required to combat it. Another general lockdown would be very difficult indeed, although local lockdowns to cope with clusters of infection might be easier to cope with.

QM – Can you comment on oil prices?

JB – The oil price chart shows a spike in 2008, following which supply got ahead of demand in order to catch up.  The oil supply is relatively inelastic resulting in a cyclical industry with prices which are prone to volatility due to cyclical imbalances.  If demand remains weak then OPEC is likely to press for a cut in production.  Climate change, and the extent to which we are willing to curb emissions, remain the big unknowns in driving demand.  It’s possible that the pandemic will have shifted attitudes to carbon emissions away from oil.

Concluding thoughts

JB – We can’t stress enough that we simply cannot forecast market movements, and neither can anyone else.  We support equity investment as part of a long term planned strategy taking into account attitudes to risk and, faced with the reality that we don’t forecast markets, Weatherbys preferred approach is passive.

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