Return-of-capital is as important as the return-on-capitalJohn Leiper - Head of Portfolio Management - 27th March 2020
Last week, we considered the debt story behind the coronavirus. The fear of a large debt overhang, as the economy slows, led to concern that households and companies could start to default on their debt. This led to a global sell-off and liquidity crunch across financial markets as individuals, families and corporations scrambled for US dollars, tightening conditions further.
At the time, we pointed to the massive monetary and fiscal stimulus unveiled across the globe which will provide households and companies liquidity to sit-out the virus before a return to normality.
What’s happened since then?
Recent equity market gains have also been broad based as evidenced on Tuesday when 90% of the stocks on the New York Stock Exchange closed higher. Historically, ‘90%-up days’ have pointed to potential market lows, or at least the start of a bottoming process. Whilst such technical indicators should be taken with a pinch of salt, multiple 90% days helped confirm bottoms in 2008/2009, 2010, 2011, 2015 and 2016 (https://www.cnbc.com)
Other examples of market stress are also showing signs of improvement. These include the US dollar index, which rose dramatically as a shortage of dollars led to significant currency appreciation, and US financial conditions which had tightened dramatically. As shown in the charts below, both have reversed over the last few days.
Following a sharp and sudden rally, the US dollar index (in white) is now falling back from recent highs, just as the MSCI World equity index (green) is also starting to pick-up. Source: Bloomberg
Financial conditions (in white) tracks the overall level of financial stress in the US. This index is showing signs of bottoming-out and improving. This is consistent with a pick-up in the S&P 500 equity index (green). Source: Bloomberg
Whilst these indicators are clearly positive, it is prudent to remain cautious. The recent improvement in risk sentiment stems from the fact the Fed has fixed (for now) the liquidity issue. They have done so by pumping huge sums of money into the economy. However, more may yet be required given the large level of global debt and potential for blockages in the financial plumbing.
This is evident in the chart below which shows the TED spread. The TED spread shows the difference between the rate at which banks lend to each other and the equivalent government yield. It is a measure of financial stress within the banking system and the fact it remains at elevated levels is a cause for concern. However, our view remains that the Fed is aware of this risk and made it clear it can and will act where required.
Monetary and fiscal policy can only take us so far. The true bottom in markets may only materialise once the number of new coronavirus cases starts falling globally.
Whilst we are not yet at that point, for me, the chart above provides reassurance that the Chinese roadmap remains in place and that most countries are working their way through the crisis. Pay particular note to South Korea which has proven resilient as detailed in this excellent article from the New York Times (https://www.nytimes.com). We noticed this trend a couple of weeks ago and purchased a position in South Korean equities at that time.
The US and UK are now also on the coronavirus journey. The positive news for the UK is the trajectory seems shallow relative to its peers. Indeed, it is reassuring to know that as of the 19th March, the UK government actually downgraded the virus which is no longer considered an HCID (high consequence infectious disease – https://www.gov.uk). For some reason this has not yet appeared in the mainstream press. Further, Neil Ferguson, who led the Imperial College report that warned of a potential 500,000 deaths has now back-tracked, confirming the virus will probably kill under 20,000 people (https://www.newscientist.com).
Changes made to the portfolios
Our overriding objective over the last two weeks has been to improve the liquidity profile of the portfolios. This approach is in-keeping with our philosophy that, at times such as these, the return-of-capital is as important as the return-on-capital.
In fixed income we reduced exposure to high yield and emerging market debt. These positions are typically less liquid and could suffer during a prolonged sell-off should one materialise. We believe it is better to be safe than sorry and as such we are now underweight these asset classes.
Within credit we are overweight investment grade bonds. This follows the Fed announcement on Monday that it would start buying investment grade bond ETFs and that it would do so via BlackRock, one of the largest ETF providers. Since then approximately $3.7 billion has flowed into the US listed iShares Investment Grade Bond ETF. We believe such flows are likely to continue and earlier this week we purchased two new investment grade bond ETFs (both issued by iShares by BlackRock).
Investment grade bonds enjoy improved credit and liquidity risk profiles, relative to high yield, and will benefit directly from the Fed’s novel decision to buy corporate bond ETFs as part of QE4. The chart above shows daily fund flows into the iShares Investment Grade Bond ETF. Source: Bloomberg
We reduced exposure on some of our European government bond positions, bringing our prior overweight allocation towards neutral. This follows Germany’s decision to abandon ‘Schwarze Null’, literally translated to ‘black zero’ but referring to Germany’s long-term commitment to running a balanced budget. Germany’s massive spending plans could see its deficit rise to 5% of GDP. We believe developed market government bonds will underperform going forward as the vast increase in fiscal spending (to deal with the coronavirus fallout) leads to increased bond issuance and higher bond yields. This is also the case in the US where we are positioned for a steepening of the yield curve.
The chart above shows the difference between the 30 and 2-year US Treasury yields. Since late February this spread has started to increase. This means longer dated yields are rising more than shorter dated yields, or to re-phrase, the curve is starting to steepen. We believe this trend will continue and have positioned the portfolios accordingly. Source: Bloomberg
In equities we switched one of our satellite positions from businesses engaged in the exploration and production of gold to physical gold itself. Gold is far more liquid than investing in companies involved in its extraction and is not subject to the idiosyncratic factors that come with the mining sector. Further, physical gold is in demand with severe shortages globally. Setting that aside, the macro case for gold also remains clear. QE to infinity and the abundance of liquidity it brings will undermine the value of fiat currencies (such as the US dollar) to the benefit of hard assets of historical significance, like gold. We continue to hold for the longer term.
Finally, as mentioned at the start of this note, we recently increased exposure to global equities. We did so on Wednesday morning following the notable improvement we saw in risk sentiment. We did so via the MSCI World Equity ETF. This ETF is large, liquid and benchmark neutral making it ideal for tactical trading opportunities. We intend to hold this position into month-end as global asset allocators look to rebalance their portfolios towards equities.
We are currently in lock-down. The introverts are rejoicing, and the extroverts are clawing at the walls. Whichever camp you may find yourself in, this can be a stressful time and I thought it could be useful to entertain an optimistic, but no less realistic scenario.
In three short weeks UK peak spread may have come and gone. The weather will get warmer, slowing the spread whilst hospitals manage a more orderly workflow and test-kit availability allows for better separation of the sick and healthy. Some semblance of normality returns, as broad shutdowns are replaced with something more practical. In the meantime, real progress is made on an effective vaccine in time for winter. Meanwhile Asia continues its economic recovery providing hope, guidance and a clear roadmap for Europe.
Returning to the portfolios, our disciplined approach to good fund management has helped us effectively navigate the last few weeks. Our decision to improve the liquidity profile across the portfolios provides insurance and protection against the worst of any downside outcome. Simultaneously, elevated cash levels enabled us to re-engage with the market this week as risk sentiment picked-up.
As always, we believe this is the time to remain calm, patient and focused on the fundamentals whilst relying on sound risk management practices.
John Leiper – Head of Portfolio Management
This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.
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Welcome to the Q2-2021 ‘Quarterly Perspectives’ publication
In its latest economic outlook, the OECD increased its expectations for global GDP. For 2020, the improvement is minimal, reflecting an upward revision, in real GDP, from -4.5% to -4.2%. But beyond that, growing economic momentum should boost global growth to pre-pandemic levels, estimated at 4.2% in 2021 and 3.7% in 2022.
Markets are ebullient, and they have every reason to be.
On Monday afternoon, global stock markets soared on the news BioNTech and Pfizer had created a coronavirus vaccine which proved 90% effective based on initial trial results. The story behind the breakthrough, which you can read here, is fascinating, not least because the husband and wife team behind the virus don’t yet know why it works.
The narrative, heading into the US election, was a ‘Blue Wave’ victory for the Democrats. Polls and betting odds favoured a Biden win and a Senate majority and investors positioned accordingly. Anticipation for a huge fiscal stimulus package, estimated at $3 trillion+, lent itself to the global reflation trade which would stimulate the economy and revive inflation, benefiting cyclical assets whilst hitting government bonds.
The ACUMEN Portfolios continued their strong run throughout October, largely outperforming the market composite benchmark and IA sectors (used for peer group comparison purposes) which lost ground across the board.
With the US election just 8 days away, financial markets are following the polls and pricing in a Biden win. The prospect for a Democratic clean sweep has contributed to the rising ‘Blue Wave’ narrative benefiting those companies that stand to benefit from Democratic party policy. Meanwhile a long/short basket of companies more closely aligned with Republican policy and values has steadily underperform.
Welcome to the Q4-2020 ‘Quarterly Perspectives’ publication.
On Tuesday Fed Chairman, Jerome Powell, made a speech at the National Association for Business Economics, during which he implied the government should err on the side of caution and provide too much stimulus rather than too little.
Saturday Night Live has a reputation for expertly parodying presidential election debates. My all-time favourite is Al Gore (Darrell Hammond) versus George Bush (Will Ferrell) and this year didn’t disappoint with expert performances from Donald Trump (Alec Baldwin) and Joe Biden (Jim Carrey).
The following is an abbreviated version of my recent article ‘A Deep Dive Into… UK Equities’ for Investment Week magazine. Follow the link and read my views on page 17.
Last week the FTSE Russell decided to include Chinese government bonds in its flagship World Government Bond Index (WGBI). The decision follows similar moves, from JP Morgan and Bloomberg, and a failed attempt to do so just one year prior which resulted in a number of reforms, to increase accessibility and currency trading options, that ultimately paved the way for benchmark admission.
In last week’s blog we discussed the ‘Nasdaq whale’, Softbank, and the role it played, alongside an army of retail investors, driving tech prices ever higher prior to the recent correction. These short-term ‘technical’ flows are driven by the options market as traders look to hedge their underlying exposure, amplifying moves both lower and higher.
The ACUMEN Portfolios continue to perform well. As you can see from the table below, performance for the rolling quarter (to the end of August) remains strong relative to the market composite benchmark and the current assigned IA sector, which I understand many advisers use for comparison purposes. ACUMEN Portfolios 3-8 were all in the first quartile and ranked in the top 15 within their category.
In a speech for the history books, last week Fed chairman Jerome Powell announced a significant change to the way it conducts monetary policy by formally announcing ‘average inflation targeting’. This means the Fed will now allow inflation to overshoot its official 2% target to compensate for prior years where inflation failed to reach that level.
Despite the fact the coronavirus has plunged many countries into recession, global equity markets are now back at all-time highs, as measured by the Bloomberg World Exchange Market Capitalisation index.
In The Return Of Inflation (5th June 2020) we made the case for a transition from the existing deflationary narrative to one in which markets start to price-in inflation.
Having identified, and benefited from, the 7% fall in the value of the US dollar index since late April, we have now turned tactically cautious.
In last week’s blog, This Time It’s Different (24 July 2020), I suggested the US dollar was on the cusp of crashing through its decade-long uptrend.
There are growing signs that the US dollar may finally roll over.
Welcome to the Q3-2020 ‘Quarterly Perspectives’ publication.
The 10 year US Treasury yield has remained remarkably steady over the last few months, particularly as inflation expectations have gradually risen.
Those stocks that outperformed during the corona crisis are the same ‘winners’ that outperformed before the crisis.
The recovery in US equity prices, from the corona crisis, has been one of the most rapid in history.
China’s economy has transitioned, from an industrial export-led model, towards services.
Commodities are nothing if not cyclical. They rise and fall in value with remarkable consistency over time.
Quantitative easing, or QE, is where a central bank creates money to buy bonds. The goal is to keep interest rates low and to stimulate the economy during periods of economic stress.
In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.
Over the last decade, the Fed has increasingly resorted to unconventional monetary policy, such as quantitative easing, or QE, to stimulate the economy.
In response to the corona crisis, global central banks have unleashed a tidal wave of liquidity.
One question I get from advisers and clients, more than any other, is why global equity markets have bounced back so far.
In the early stages of the Corona Crisis of 2020, the global economy faced a liquidity crisis.
In an unprecedented day in the history of oil trading the price of the front month contract for West Texas Intermediate (WTI) oil fell below zero to -$37.63.
In a trading update last week, the listed adviser warned that the outbreak has caused commercials conditions to become “extremely challenging”
Bosses at Tavistock Investments have taken a voluntary, significant pay cut…
As the world’s reserve currency, the US dollar is the go-to currency. It is used to price assets, complete transactions and as a store of value.
Brian Raven tells Proactive Investor its two protected UCITS trusts have proved themselves during the current market volatility caused by the coronavirus pandemic.
The coronavirus has brought economic activity to a virtual stand-still and transformed a strong global economy, with lots of debt, to a weak economy… with lots of debt.
In the past three weeks, global equity markets have fallen almost as much as in the Financial Crisis of 2007-08.
Investment sector veteran Hugh Simon has taken a near 5% stake in wealth consolidator Tavistock in a strategic partnership.
In the past week, global equity markets have fallen again and yields on developed market government bonds have collapsed even further.
Halcyon days, global equity markets have fallen again and yields on developed market government bonds have collapsed even further.