These are extraordinary times. The death toll from the coronavirus outbreak could potentially be shockingly high. Governments around the world are taking extreme measures almost on a daily basis that are unheard of in peacetime, because, to put it bluntly, humanity is at war with the virus.
There has been a lot of news for markets to digest. Recent weeks have seen wild gyrations in asset prices. Inevitable corrections in valuations were surely exacerbated by the near-complete absence of liquidity. For understandable reasons, many investors may be contemplating worst-case scenarios and may be turning towards defensive capital preservation strategies after prices have corrected.
In our view, this is not the time to sell. Indeed, as long-term investors, we are looking for opportunities to add risk, not reduce.
To arrive at this view, we devised a strategy made up of three pillars: the virus, the outlook and valuations.
The temptation in moments of crisis is to become fixated on the worst-case scenario, turn defensive and focus on preserving capital. We think that is a mistake: now is not the time to sell. The correction has already occurred and assets are already priced for pandemic and arguably panic.
The outlook is uncertain, but that does not excuse inaction. We do not have the luxury of being able to wait until there is complete clarity about the final impact of the virus on society and the economy before taking investment decisions. Markets will price in the end game for COVID-19 long before all the uncertainty has dissipated.
As long-term investors, we need to take a stand on the ultimate human, social and economic cost of the virus and then benchmark those views against current valuations in the market. Prices look to have overshot, fuelled by panic and dislocations in markets.Valuations are starting to become attractive and we are looking to add risk, not reduce.
To be clear, we believe that the situation will get worse before it gets better. There will be a catastrophic loss of life and a sharp contraction in activity in coming weeks. The authorities may be forced to impose multiple shutdowns in coming months to keep the virus in check. However, we believe that the global policy response will eventually turn the tide.
We believe that a combination of factors will ultimately help society learn to live with the virus without recourse to endless shutdowns – in particular: rising acquired immunity within the population; diagnostic and serological testing on an industrial scale; increased capacity within the healthcare system to deal with acute cases; and the adoption of best practice from around the world on containment strategies outside of lockdowns.
Furthermore, we take comfort from the already significant and still building economic policy response to the crisis. The shutdowns will place huge stress on companies and households, but the more the global policy response moves towards the “socialise all losses, whatever the cost” mentality, the more confident we become that the economy can weather the storm.
The game-changers are obviously the arrival of effective antivirals and ultimately a vaccine, but at least as far as the latter is concerned, there is a timeline of many months of trials ahead of us to demonstrate that any vaccine is safe, and that will be difficult to compress. However, credible news on progress will likely cause the market to fast-forward to the end game.
Equity valuations are starting to look attractive: our dashboard of valuation metrics across jurisdictions has shifted from red to green. The S&P 500 equity index has fallen by about a third, reflecting a decline in both earnings expectations and a drop in the P/E ratio despite much lower bond yields. Further declines in earnings expectations pose a downside risk to valuations – particularly in a multiple shutdown scenario – but the significant increase in the equity risk premium could act as a cushion for bad news on earnings.
Looking at a combination of factors, we do not believe this is the time to sell, but rather add risk selectively.
Of course, there are risks around this view and in effort to keep you informed, we will be providing an update every Wednesday that takes a closer look at the status of the virus, the outlook and valuations.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.