March 2020 Review

March Madness?

During my time working in the United States in a previous life, March was notable among sports fans for the annual National College (NCAA) Basketball Championships also known as ‘March Madness’.  Needless to say, it didn’t take place this year and apologies to non-sports fans for this reference but for many investors, March 2020 did feel like madness.  Yet it was real as the ultimate in surprise shocks derailed a long rally in risk assets notably equities and corporate bonds.

Already fragile markets fell precipitously when it became clear over the weekend of February 22nd and 23rd that the Covid-19 virus had made significant landfall in Europe, notably Northern Italy.

Subsequently, it has become clear that isolated cases had been prevalent in western economies since January.  However, it was the spike in cases reported that weekend in February that shook financial markets and continued to dislocate asset prices in the first three weeks of March with heightened volatility.

A not inconsiderable sideshow that also heaped more volatility on markets was the fall in oil prices as Saudi Arabia and Russia fought over market share, caring little that the price of oil plummeted.

To give some context to market volatility and price movements, the US S&P 500’s average daily change was 5.2%, easily exceeding the previous record of 3.9% set in November 1929. Unprecedented became a word used most days.

Between the close of business on February 21st and March 23rd, the UK ‘s FTSE All Share equity index fell 33.6%.  In the final week of March, the same index rallied by 14.0%.

Despite the end of month rally the US S&P 500 index fell by 19% over the quarter, the following chart of quarterly returns over the past 100 years puts that into context, as does the ensuing market appreciation in the following quarters.

Source: Web Returns, YCharts

 Liquidity and Solvency… 

 … are two different issues but in times like these, it is key to differentiate between them. Much like the price of credit versus its availability – as was illustrated in the 2008/9 period when the price of credit was lowered substantially, but banks had to have their arms twisted to make it available and many good companies either went under or nearly did.  But, as Mark Carney, the recently departed Bank of England Governor remarked, banks might have been the problem then, but they are part of the solution now.

In our most recent updates, we have referred to the short-term illiquidity of some of our favoured assets, notably investment trusts, which has a greater impact on the Dynamic Fund as it holds a number of them as preferred diversifiers – many with inflation-related features.

These are sound, solvent businesses with little disruption expected from current events, yet their prices have plummeted as emotional or forced sellers entered the markets but failed to find market-makers willing to take on inventory. A few became sellers at any price with the result that many investment trusts quoted on the London Stock Exchange showed savage price falls but on not much volume.

As a daily priced fund, Dynamic has endured greater than expected price volatility as a consequence of poor liquidity in extreme circumstances in the investment trust market.  However, some of the prices quoted became eye-wateringly attractive leading us to put some of the cash built up in February and early March to work.

Unsurprisingly, having not consumed much inventory on the way down through price avoidance, market-makers had little stock to offer to buyers like ourselves on the way up.  However, we were able to top up existing positions at attractive levels in companies such as Urban Logistics which specialises in last-mile distribution centres close to major towns and cities – much in demand right now.

The chart below from Winterflood Securities illustrates the movement in investment trust discounts to net asset value (NAV) over the first quarter of 2020 and underlines the market movements referred to above.

Source: Winterflood Securities

What Next?

Is the end of March rally a bottom?  We don’t know, but as the first chart in this review illustrates, history has normally delivered a positive period following such a negative quarter.  What it doesn’t show is, for those concerned that they have missed the bounce, there is often a second bite of the cherry and hence both Dynamic and Growth have retained 10% cash positions.

We don’t know how long the Covid-19 sudden economic stop will last and therefore how long the ensuing recession will last.  It will certainly be deep.  Income seekers will be concerned about the prospect of widespread dividend cuts which is one reason why we prefer a total return methodology to investing.  In the meantime, all eyes are fixed on infection and sadly, death rates in Italy.  Cases may have peaked in Italy but most of the rest of Europe and North America have yet to reach peak infection.

What governments and central banks have done is provide massive fiscal and monetary support.  Their priorities are clear – try to keep the health service capacity intact, keep a lid on unemployment and have a short, sharp recession.  As taxes will not be increased, government funding will come via the bond market issuance.  And why not?  With ten-year UK government (gilt) yields at 0.30%, I’d rather be a borrower (issuer) than a lender (buyer) of government bonds.

There should be plenty of economic impetus when the other side of this economic shock is reached.  What we do know is risk asset markets will have turned positive before the recession is done.

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