Covid-19: (A Very Early) Where To Next?

Covid-19 has triggered a savage sell-off of asset classes across the board. It is too early to make any calls with certainty, but we believe there are already some things to think about from an asset allocation perspective for when the time does come to deploy.

This situation is constantly changing and we will endeavour to maintain communication of our thought processes throughout.

The world continues to be a rather eventful place since we last wrote (or somewhat non-eventful considering most are essentially confined to barracks). At the time of writing this article (24 March 2020), we are officially on track to have the worst month since the Great Depression. 

Some additional key headlines include the following: 

1. A 1.8tn USD fiscal stimulus package  was blocked by the Democrats in the US Senate;
2.  A 2.5tn package was proposed as an alternative by the Democrats;
3. 500bn Euro stimulus proposal from the Germans; 
4. Lockdown in the UK;
5. A third stimulus package in Australia;
6. The Fed’s QE infinity (i.e. the initial 700 Billion USD bond buying program was increased to unlimited purchases of US Treasuries with no end in sight).
7. RBA’s first round of QE; and
8. ECB’s QE Infinity.

Forgive us if, by the time you read this article, the world is a very different place (again). We seem to be moving at a pace not seen for quite some time or indeed ever in our lifetimes. For example, the ECB’s bond buying program was announced at 1am on Sunday and the Fed’s announcements around Repo markets came at 11 PM on Sunday. It seems that central bankers are on 24-hour cycles now.

So where to next?
 
The simple answer is that we have no definitive idea. It was rather telling that when the Federal Reserve announced the QE program, the reaction from the markets was rather underwhelming, to say the least. The continued sell-off makes it an unprecedented time for monetary policy. The notion of the Greenspan or Fed put has seemingly run its course, making some previously unthinkable taboos rational. For one thing, the continued sell-off in the markets puts immense pressure on the global financial system, squeezing liquidity and putting a strain on the credit markets. We see two courses of action that look increasingly likely from the point of view of the regulators: 1) let the markets continue in freefall with subsequent injections of liquidity and regulatory interventions (such as a ban on short-sales and leveraged ETFs or the sale of puts); or 2) the freezing of markets all together until such time as we have more clarity on the actual impact of the virus or get it under control enough to have it priced into securities as a one-off scenario.
 
The second course of action being unpalatable as the situation currently stands, we will take some time to elaborate upon what the first scenario looks like. 
 
While it is not clear how we should be approaching investment in the short term over the medium to longer term we do know that this is an event with an end and that this situation while unfathomable at present is providing us with a great entry point to own assets at prices we have not seen in years. It does not make sense to sell at this point in time unless you need the cash, but we do have to realise the market may not bottom before May. As is the usual case the selling has been correlated across the board. From safe-haven assets like gold to bonds, alongside equities as people and institutions alike look for liquidity. The selling in gold is probably a shorter-term move to cover losses in other asset classes. 
 
We are increasingly seeing bonds and equities sell off simultaneously. This is a scenario we have previously elaborated upon and exactly why we did not necessarily see bonds as a good diversification tool from an asset allocation perspective. For example, take the four largest bond ETFs, iShares and Vanguard (AGG, BND, LQD, BNDX) which all trade at close to a 6% discount to NAV. 
 
As it currently stands, we will continue to see volatility as the markets try to price in future growth and central banks continue to intervene. This will be a post-virus world that is markedly different from an asset valuation perspective to that which preceded and that is on the lower side.  At this stage, it might be worthwhile to hold steady and NOT crystalise losses if you can avoid it. We would not necessarily suggest that it is time to buy but as we go through the next few months and there is more clarity around what the various outcomes might look like we may get some decent buying opportunities. From an asset class perspective we consider it more likely that, while equities and bonds go down simultaneously, the quickest on the rebound will be equities. 
 
In the medium term, we will see the USD continue to appreciate and a gradual revaluation of safe-haven assets and currencies such as the CHF (Swiss franc) and the Yen. However, over the longer term there is a larger question mark. For one, the past year has brought to the forefront an increasing amount of policy uncertainty and division when it comes to economic management. In the US, the alternate stimulus proposal in the House by the Democrats has come close to the notion of helicopter money, ranging from:

1. Nullification of Executive Orders on collective bargaining;
2. Union representation on airline boards;
3. Permanent raises to the minimum wage;
4. Cancellation of all debt by the US Postal Service to Treasury;
5. Student debt forgiveness of up to $10 000; and
6. Permanent expansion of Obamacare

Granted some of the above asks are rhetoric for an election year, we would however suggest that all this spending is bound to have inflationary pressures. Especially with regards to debt forgiveness and hikes to the minimum wage. Closer to home, the stimulus measures we have seen, ranging from unemployment benefits to hikes in student benefits, also have a similar impact. As it currently stands the packages in Australia amount to 88bn AUD but we would go so far as to say that this is merely the beginning with more to come. 
 
As we have previously mentioned some of the best buys when the markets do rebound (in this context) will be in spaces like infrastructure and consumer staples. These might be in niches such as renewables (in fact the Democrats’ alternate plan had a substantial amount of monies allocated towards subsidies in solar and wind) or wastewater treatment. Another well-performing asset class might be precious metals, namely gold, while silver might be a higher risk bet. 
 
Bonds, on the other hand, will be another story altogether. In fact, we see the biggest risk here. There is potential for a situation where inflation eats away at the real value of the debt. It might make more sense to buy into utilities or alternative bond proxies that are inflation-indexed. However, the above statements would be on a much longer time frame than that of the next half-year with a bottom not likely to be seen until May at the very least. 

Remember, when it comes to both Covid-19 and investing we just need to be sensible. Take appropriate precautions, stay informed, make logical decisions and don’t panic.

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A Message From TAMIM

​This is an evolving situation, the 'facts' and figures are changing day by day. One must stay informed and have their opinions and actions evolve accordingly. Stay safe, take appropriate precautions and be sensible.