REVIEW OF FINANCIAL MARKETS - T1 2020 - Report Prepared by Generation ALFA

  • -March has been the most dramatic month for the financial markets since October 2008.The fall in the equity markets at the end of February spread to all other asset classes and very few managed to end the month rising.
  • -Chaos has been observed even in the safest asset markets, due to panic sales to raise cash at any cost;yields on 10-year Treasury bills first fell 1.14% to an all-time low of 0.32%, before rising to 1.3% and finally ending March at 0,67%.
  • -The price of gold fell 12% in seven sessions, margin calls having forced investors to liquidate positions.
  • -Huge volatility was also observed in the currency markets due to the dollar rush, and the EUR/USD pairtraded in a wide range: rising first to 1.06, then correcting to 1.15, before returning to 1.10.
  • -The Covid-19 pandemic obviously caused this tension in the markets, but it was also compounded by thecollapse in oil prices; Russia withdrew from OPEC + talks and rejected a Saudi proposal for a further reduction in production. The outcome led to a plunge in oil prices by more than 50% in March.

Some General Thoughts

  • -Like all others, we can't know when the Coronavirus infection curves will flatten, nor when and how fast lockdowns will be lifted.
  • -Maybe Goldman Sachs is right, and U.S. GDP will contract 34% (annualised) in the second quarter.Maybe Citibank and Bank of America are right and it will "only" be 12%. So what? If anything, the huge gap between those extremes proves how little sense such forecasts make.
  • -What's certain is that the global economy will fall into a deep recession in the second quarter. What's likely is that a gradual recovery will take place in the second half of the year. Why?
  • -Unlike other recessions –this one isn't structural but … "biological". It's no one's fault, really. This gives governments and central banks an excuse to act more swiftly than ever before, and with no limits.
  • -We can't know if markets have bottomed already or if it will get worse before it gets better. All we knows that financial markets tend to discount today what they expect to happen tomorrow and that, right now, they have already priced in deep recession, but not yet a recovery.
  • -Short term, some prudence certainly makes sense. But it's too late, in our opinion, to think about protection. From now on investors should only concentrate on when, where and what to buy.

A Dark-Black Swan

  • -A "Black Swan" is an unpredictable, extremely rare event with severe consequence
  • -With a large portion of the World's population directly affected by the Coronavirus pandemic –respectively by severe measures taken to combat it –this is arguably the darkest Black Swan since WW
  • -What surprised not only us is that "developed" (?) countries were unable to benefit from the experience of China and South Korea to combat the virus, nor from Hong Kong and Singapore which managed to contain it.
  • -At the same time when Covid-19 cases exploded exponentially, oil prices imploded on the back of a fight for market share between Russia and Saudi Arabia. Or could it be that the two teamed up against the U.S.?

  • -For the average consumer, low oil prices may be good news. For the (highly indebted) energy sector-and subsequently for global financial markets –this Light-Black Swan came at the worst possible moment, pouring more oil on an already devastating fire.

Central Banks' Responses: "Whatever It Takes"

  • -The fiscal and monetary response to this pandemic is unprecedented, in terms of speed and size.
  • -Central bankers and governments are outbidding each other with ever larger stimulus measures. The $5 trillion package pledged by G20 leaders on March 26 gives an idea of what's in the pipeline, still counting.

  • -How much it will be at the end doesn't really matter. What matters now is that governments and central bankers will do … "whatever it takes".

What consequences ?

  • -Fiscal deficits will explode and debt to GDP ratios will again be on the rise.
  • -Not sure if this will lead to a government debt crisis further down the road. After all, Japan demonstrates since a while that an extreme debt to GDP ratio can be sustainable.
  • -However, when looking at ballooning public debt, investing in gold and equities may prove safer, over time, than holding government bonds … and more profitable too.

What about Cash ?

  • -Some facts: despite the incredible returns of risky assets in 2019, money market funds saw important inflows last year.
  • -When markets crashed in March, cash became "Caesar" as money market funds faced record inflows of over …. half a trillion USD!

  • -What statistics don't show is all the cash hoarded outside of money market funds, namely on bank accounts. Trillions?
  • -Cash is a great asset class … but only if put at work when opportunities arise!
  • -Holding (too much) cash over the long run is … "useless", very much so when it doesn't offer returns.
  • -Sooner or later, investors will have to redeploy cash – and we think it will be sooner, i.e. in the course this second quarter 2020. •
  • -In our mandates, we are still overweight cash but intend to gradually redeploy it in coming weeks, either after additional selloffs or then if we get better visibility on an end of those --lockdowns.

What about Fixed Income?

  • -During the week ending March 20, Fixed Income Funds in all categories had to deal with the hugest outflows on record, totalling 108,9bn USD.

  • -Bid offer spreads for individual bonds widened to as much as 5% for Investment Grade and as much as 10% for High Yield paper. On 20% of the EM and HY bonds, sellers were not able to find any bids.
  • -The courageous who regarded this situation as an opportunity, could benefit from it if they bought ETFs; because they trade at no bid/offer spread and –in times of stress – often at a discount to their Net Asset Value.
  • -We have reduced exposure to riskier emerging market and high yield bonds while holding on to higher quality bonds and secured loans.
  • -Thus, we are heading into the new quarter on the cautious side and watch closely the liquidity in the fixed income market.

What about Equities? Some "best guesses"

  • -1Q20 earnings will be bad, 2Q20 earnings awful.
  • -Forward earnings estimates are obsolete, even though analysts may disagree, because it's their job.
  • -In coming weeks, the only tangible information we will get from companies will be about dividend payments and share buybacks … put on hold. Those bad news are largely discounted.
  • -In other circumstances, a Bull/Bear close to zero would be a "screaming buy". In the current situation, it may be a bit too early.

  • -We are still underweight equities but will gradually increase exposure from here, ideally at lower levels, if not when markets show signs of stabilization.
  • -Investors shouldn't only consider the obvious winners (Amazon, Microsoft, Zoom), because "crowded places". When markets rebound, the most battered sectors (banks, energy, hotels and airlines) may well recover the most.

What about Gold?

  • -Physical Gold is nobody's liability … unlike bonds, equities or cash. Gold doesn't have a counter party and thus also doesn't carry counter party risk.
  • -That's why central banks hold Gold as the ultimate store of value and that's why individuals should also own some.
  • -When central banks "printed money" after the last crisis, gold more than doubled, also because it's the only currency which cannot be printed … for free.
  • -Now central banks are printing again, faster and more than last time. We are not saying gold prices will double again! We just think that the current environment is again favourable for gold.

  • -We recommend ETFs backed by physical gold because more liquid than gold barres and tradable in any amount. Our favourite ETF is the one of Cantonal Bank in Zurich which stores its gold in Switzerland.

What about Private Markets?

  • -Listed Private Equity firms (ETF) and listed Real Estate/REIT ETFs suffered more than 30% each, in line with the MSCI Financials, with daily volumes being at least 4x higher than average.

  • -Some, if not many of them, are probably trading below the value of the asset and reflect the fact that, should the asset be sold today, there would not be any real buyer; or that the estimated growth shall be revised downward, which is true.
  • -Private Equity, Private Debt and Real Estate offer one main advantage, is that the GP's (the manager) have long term committed capital and long term investment cycles, allowing them to also engage in business/assets at current depressed valuations.
  • -In this environment, we would consider secondary funds (who would buy investments at discount from "forced sellers"), real estate/infrastructure assets and/or private debt for companies able to grow market shares in this cycle (typically debt for acquisition).

Mirko Visco

Managing Director and CIO of Generation ALFA