Words Of Comfort - If There Can Be Such A Thing

Robert Swift takes some time out to provide his thoughts on the developments of the past week. Between the coronavirus situation and the Russia Saudi oil showdown, there is a lot to unpack. 

Author: Robert Swift

We didn’t manage to escape the recent sell down. We have had a mystery global plague followed by a shocking stunner. These are the Corona virus going global (surely not a surprise to have flu in Winter, but where does this one stop?) and a real stunner; the Russia Saudi showdown which sent oil prices down in a shocking way. If a global commodity that’s produced  and consumed all over the world 24/7 can simply drop 30% in a day, that should scare everyone. That was the stunner.

Everything we’ve been saying about the nightmare scenario of too much debt, the failure of ZIRP to do anything for the real economy and a lack of capital in financial institutions to provide orderly markets, is now feared to be true and the sellers of risk assets claim we are now faced with the reckoning.

We had positioned ourselves defensively or so we thought. We were meaningfully underweight banks (don’t own any) and energy. However, in such a large and rapid fall it doesn’t matter. Sellers become irrational and dump regardless. For what it’s worth investors with exposure to sovereign bonds made quite a lot of money as long term yields fell to unprecedented levels. We have always advocated having a mix of risk assets. We do not want to manage all of your money – just some of it.

Equities have just become cheaper relative to bonds but we understand reluctance to buy in right now. Sometimes however what is uncomfortable is profitable.

We were defensive partly because we like ‘Value’ as an investment philosophy and partly because the recent returns had been so strong and driven by unrepeatable events. Lower interest rates, margin expansion, stock buybacks, indexation and lack of alternatives with sovereign bonds yielding very little if not negative and investment grade stuffed full of marginal quality have pushed us into bubble territory.  The market was keen to find a way lower and the fall wouldn’t be so hard if we weren’t standing on the higher rungs (highest) of the valuation ladder.

Read Robert Swift's ​2019 A Surprisingly Good Year for Risk Assets: 2020 Outlook

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So what do we all do now?

Corona virus or Covid-19 is unknowable in its magnitude and duration, but we know that it’s global and thus travel and trade will be impacted hard and that impact will spread to other sectors. The response has been clumsy and/or slow and the virus is now being allowed, and perhaps encouraged, to create an economic impact way beyond what is merited. We have to deal with this reality and not recriminate. We however look at Asia where it first originated and see declining rates of infection and people leaving hospital cured. This will end and stated brutally it won’t kill young healthy (productive) people.

Oil price falls are effectively a large tax cut to Western countries. Maybe not so much this time given the recent boom in USA shale production such that the USA is now self-sufficient, but put another way, would investors rather have had a 40% increase in the price? That’s supposed to be rhetorical! Some shale oil companies will struggle to survive as may some majors with heavy debt loads. Shale companies are also represented as a disproportionate percentage of the HY bond market so be careful investing passively there. Banks have obviously lent to oil companies (and we worry that bad debt provisioning is anyway too skinny), that regulators still have banks in their sights as a source of finance; the yield curve is flat impairing profitability; and that much of the banks’ collateral may be in jeopardy if oil companies continue to be burdened by the stranded assets problem which accompanies the demand for a greener economy.

Fundamentals are unknowable in the short term and so the technicians and their triple tops and Fibonacci levels take over here. We are pragmatic enough to pay attention to what is being said even though we believe it is of dubious merit. Where we have cash, we have been nibbling a little on down days. We bought yesterday (Monday 9th March) in Asia and the USA.

Briefly in summary:-
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1. With sufficient measures now being taken this virus will be on the turn downward.
2. Investing in banks and oil stocks would be too early, notwithstanding their large falls.
3. Governments are correctly discussing expansionary fiscal plans – note to these governments - please do NOT again bail out companies whose managements privatise profits and socialise losses.
4. The real long term problems of imbalances and debt overhang remain but strangely enough the economic shock is now resulting in fiscal packages that we believe should have been in place years ago and if done correctly, will reduce these stress points of imbalance and unequal debt sharing in the global economy.
5. Funny how action isn’t taken without a crisis? Maybe this double whammy of Covid 19 and oil provides the start of real economic growth as a result of government fiscal spending?