Gerrit Smit, head of equity management at Stonehage Fleming, looks at contrasts between the covid-19 crisis and the two other major economic and financial crises of the past, and says that market fear could be three-quarters over.
The fear driving markets since February is due to a kind of dread that history will repeat itself. Investors worry that we are in the depth of a recession to rival the Great Depression or the kind of downturn that followed the Global Financial Crisis. But we believe circumstances are very different this time and that there are some signs most of the extreme fear may well be behind us.
Faced with the coronavirus pandemic and the very hard measures taken by governments to control its spread, we have all suffered a terrible shock over the past weeks. Financial markets have too. As sentiment plays an important role in investing, it is unsurprising that fear has recently been the major driver of markets. Although investing on fundamental principles requires a cutting-out of noise created by the pervading panic, it is important to try to gauge market sentiment and establish why things might be different this time.
During the Great Depression, the US Federal Reserve was actually the major problem. It employed a tight monetary policy, raising interest rates throughout the crisis, which, with hindsight, was exactly the wrong thing to do. With the gold standard at the time there was a huge flight to gold, which caused the collapse of the dollar and many other issues besides.
Currently, the opposite is true. Rather than being the problem, the Fed today is a major part of the solution. Having adopted a wartime footing, it is pledging to do all it can to ensure liquidity and prop up the economy. Although a recession cannot be avoided altogether, the approach might, with a fair wind, limit the damage and support a recovery.
Fears that today’s situation shares similarities with the recession that followed the Credit Crunch also seem misplaced. The deep problems then were due to a liquidity crisis created by a flawed banking system, which has since been reformed. Today, in contrast to previous crises, because it is about human health and life, the responses from governments and central banks have been incredible, making huge amounts of liquidity available where it is needed, at an unprecedented speed.
Compared to a few weeks ago we now have more information about better diagnostic testing, more testing capacity, potential anti-viral drugs and a number of vaccine results holding some promise. We now also know that social distancing measures are effective in flattening the infection rate. We also know that if a second wave occurs, the market and authorities are pretty well informed of the risks we face and are in a better position to consider clearly how to manage the situation.
It is largely due to this increase in information and a greater understanding of the risks that the worst of the fear, it seems, may be over. Our own capital market measures indicate that we are around three quarters of the way through the worst fears associated with the pandemic.
Assuming that sentiment has found its floor, investors should keep their eye on the horizon rather than the immediate economic outlook. Although there may be a stop/start period in getting economies going again, we think the direction of travel for the global economy towards the end of the year may well be in a positive direction.
Historically recessionary periods have proven to be good times to invest, not to disinvest (as those who are fearful may wish to do). For us, the current environment is not one of buying the so-called market. Rather it is an environment of very active stock selection, selecting only high-quality businesses and being very careful with your choices and considerate with valuation.
I am reminded of Howard Marks’s quote: “You cannot predict, but you can prepare.” Not many of us can foretell exactly what will happen with the issues related to the virus and the economy but we believe we should be invested and can prepare by owning the right quality businesses.
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