On recent market volatility
March 11, 2020
As worldwide efforts to contain the coronavirus (Covid-19) escalate, global financial markets showed severe volatility in recent days and weeks. We have compiled comments from professional managers around our global, multiboutique asset management company, for a read on how professional investors may view risk and opportunity in their specific areas of the market currently.
At our most recent Macquarie Fixed Income Strategic Forum in January, the outbreak of coronavirus was in its early stages. We assessed this new market influence in the context of the “contained environment,” whereby since the financial crisis, central banks have been repeatedly required to act to contain risks and prevent any faltering in the economic growth outlook. We noted that we have often been asked what could end the contained environment? In response, we have referred to the possibility that something could eventually crack or tip the container over with one possibility being some form of unexpected shock, that would cause demand to slump regardless of central bank action and that this could take the form of a geopolitical event, a natural disaster, or indeed, a pandemic.
The question we pondered was “whether the coronavirus will test the central bank contained environment. Indeed, it seems likely that more easing will be required; however, its effectiveness is questionable as the virus would primarily impact Main Street, not Wall Street. Given the low-altitude growth environment, and to use the technical terminology: Could the central bank firewall be susceptible to a virus infection?”
In the weeks since, the situation has escalated with the global spread of the virus coupled with oil price declines following the breakdown of talks at OPEC. Volatility has increased, risk assets have sold off and central banks have stepped in to provide emergency support.
While the backdrop is one of uncertainty, in Macquarie Fixed Income, our positioning prior to these events was already relatively defensive reflecting our more cautious tone relative to market optimism. We had de-risked our portfolios awaiting a repricing and better opportunities. We will continue to closely monitor the situation and adjust our portfolio positioning accordingly.
— Brett Lewthwaite
US Municipal fixed income
The municipal market has generally been a strong performer with rates rallying and Lipper bond fund flows solid. The market has seen $26 billion of inflows year to date, a record pace. Last week was the first time in 60 weeks that the market experienced a small outflow, of $250 million (source: Lipper). A key element to the performance for the municipal market will be whether outflows do escalate for a prolonged period, due to uncertainty.
As is typical in the case of extreme rate declines, the municipal market has rallied along with US Treasurys but has dramatically underperformed. The municipal ratio in 10 years has surpassed all-time highs and has approached all-time highs in 30 years (source: Lipper). We view this as a long-term opportunity for “crossover” investors.
The market has started to see a bifurcation in the performance of credit segments. High grade municipal bonds continue to rally with Treasurys, albeit to a lesser degree. Credit has begun to weaken the last two trading days as spreads widen in sympathy with corporate high yield spreads and selling from exchange-traded fund (ETF) investors. The abrupt widening in credit has made credit issues significantly more attractive than just a week ago. We look to be opportunistic when we believe the conditions warrant.
The coronavirus, lower oil prices, and the resulting economic impact may impair certain sectors within the municipal markets if this turns out to be a prolonged epidemic here in the United States. This is relatively early and only time will reveal its longevity and subsequent impacts. As always, we will utilize our fundamental credit research to seek opportunities for our investors amid the increasing volatility.
— Greg Gizzi
Equities: The long term means long term
At times of market volatility, we remind long-term equity investors that their time horizon should, by definition, be a matter of years, and not weeks. By focusing on long-term horizons, our independent investment teams strive to protect against both the risk of severe near-term portfolio declines while remaining cognizant of the risk of becoming too defensive and missing out on an inevitable market recovery.
This may not make stock-market volatility easy to bear, but it is specifically at these times that we as asset managers spot opportunity when viewing crisis events and down markets. Market volatility often brings investing opportunities for long-term gain to active equity managers, and it’s worth viewing markets’ current state of play with this in mind.
Equity teams across Macquarie Investment Management own their own investment processes and unique views on the markets as part of our multiboutique structure. We provide views at this time about opportunities potentially being uncovered within individual teams’ investment universes, comments on macroeconomic outlook, defensive positioning, and relevant market issues being monitoring in the near term.
During this rapidly unfolding situation, the team is having ongoing discussions regarding risks and opportunities. We are also having conversations with the senior management teams of our holdings and companies we are considering for investment, to get a sense of near- and long-term implications. As we navigate this volatility, we believe that it is imperative that we continue to follow our value discipline and process.
US Core Equity
Our small-cap core portfolio has held up relatively well given the current environment, as our lower-beta portfolio has helped protect during the selloff. Our disciplined portfolio construction process, which includes a daily review of risk factor exposures, allows us to remain confident in our positioning. We are taking this opportunity to strategically deploy capital in industries that we believe are attractive at current valuations, while considering a subdued growth environment if on the horizon.
Given the fluidity of the market, we are modeling scenarios for our companies where we could either have a recession or a recovery, confident that the portfolio is well positioned, with potential to outperform the market in either environment.
— Francis X. Morris
Small- and mid-cap value
We are considering both the near-term and long-term implications of potentially lower growth rates in GDP, cash flow, earnings, and capital spending. Markets historically have been volatile and we wouldn’t expect that to change. In most market declines, higher-quality companies decline by less than lower-quality companies, while in this environment, we are unfortunately experiencing the opposite. The decline in interest rates and the price of oil has created a selloff in the sectors of the market that have heavier weightings in value portfolios, notably financials and energy. Policy decisions have created those declines with the hopes of supporting the consumer, which is one of the most important contributors to our economy.
We are continually evaluating the fundamentals of each company that we own and researching new companies for our portfolios. We are confident in our overall positioning and intend to make any adjustments needed to maintain a favorable risk-return profile for the portfolios. We anticipate companies will continue to provide free cash flow to shareholders through share buybacks, dividend increases, and debt reduction, which should be rewarded once markets stabilize.
— Chris Beck
Small- and mid-cap growth
The coronavirus concerns are having a significant effect on the economy. In particular, we are seeing weakness in travel, energy, and retail, which is broadening out into the credit markets as well. That said, this is not like 2008. Banks are much better capitalized and consumers are in a solid financial position with credit scores at all-time highs and wage and savings rates healthy going into this crisis.
Our investment style is focused on disruptions, where better, cheaper, faster options emerge for how business is conducted for certain industries. Trends such as personalized medicine, software as a service (SaaS), and higher-quality foods are early in their formation and will continue to grow regardless of the current crisis. Others such as mobile banking, virtual healthcare, and streaming media are actually getting a tailwind from the crisis as people adjust their spending habits.
While we don’t know when the crisis will end, we believe the correction in the equity markets is often a buying opportunity, and the creative destruction process that makes capitalism so great continues on despite near-term diminished visibility.
— Alex Ely
We believe there will be significant short-term impacts on both supply chains and consumer demand. We’re encouraged by the signs from Asia that control measures are effective at slowing transmission of the coronavirus. In China, outside of Wuhan, new cases are down dramatically and there have been positive trends in South Korea. While it may take time for things to fully return to normal, governments are taking measures to support stressed areas of local economies.
Timing the exact bottom from a financial markets perspective is always difficult, and price action in developed markets will likely continue to influence emerging markets. We expect short-term price action to continue to be volatile.
The starting point for emerging markets is important to keep in mind. Emerging market stocks were trading at discounts relative to the US, coming into the current selloff. We expect that emerging markets will generally be in a strong position to benefit from the recovery coming out of this situation.
External shocks and volatility are common to the markets that we invest in, and our strategy has been managed before through multiple cycles of severe macroeconomic stress and stock market volatility. We invest in businesses that have sustainable franchises, including resilience to deal with external shocks, and we believe these companies will be better able to withstand the current period of volatility and may emerge with stronger competitive positions. We also believe that key secular trends will remain intact longer-term, and that companies we hold will be well positioned to benefit from these. We will continue to manage the portfolio closely, stress-testing our assumptions and seeking to take advantage of opportunities as they unfold.
— Daniel Ko
Global growth expectations steadily retreated since China first took measures to stem the coronavirus spread, which severely curtailed commodity demand estimates. As the coronavirus continued its rapid spread globally, demand estimates for key commodities continued to ratchet lower in step. Ceteris paribus for supply, lower demand obviously equates to lower prices across the commodity chain.
Crude oil witnessed the most violent price action of any commodity. On Friday, fissures within the Organization of the Petroleum Exporting Countries Plus (OPEC+), specifically Saudi Arabia and Russia, arose leading to an all-out price war between the two nations. Russia declined to participate in a Saudi-led output cut in an effort aimed at delivering a blow to US shale producers. Saudi Arabia responded to the Russians over the weekend with historic price cuts and talk of a supply increase. This supply windfall in the face of curtailed demand due to the coronavirus led to a 25%-plus collapse in crude oil prices on Monday.
Not all is bleak on the commodity front, with several winners amid this chaos. Gold once again provided a secure store of value. Moreover, there are several beneficiaries within subsectors. For example, tanker companies stand to benefit as more supply gets shipped out of the Middle East and a steeper oil contango will likely incentivize crude-tanker storage economics.
While natural resources equities have struggled in this environment, we are starting to see value emerge. Over the coming weeks as we get more concrete economic data and firmer details on the monetary and fiscal response, we believe there will be opportunities to deploy capital into a growing list of attractively valued opportunities.
— Sam Halpert
Real estate investment trusts (REITs)
Real estate sectors are bifurcated into those with more or less economic sensitivity. Clearly, hotels, industrials, and regional malls have been negatively affected. However, there are those sectors that are performing relatively well such as self storage, manufactured housing, data centers, cell towers, and apartments.
This selloff began with the coronavirus, but now the oil production increases have added another element of volatility to the market. At this time, with worries over the coronavirus, we are looking long term and believe that current prices generally offer our investment team some attractive entry points. We can’t time the bottom, but certain sectors such as cell towers, retail-focused data centers, and healthcare are looking more attractive. Our view on hotels is more measured given the uncertainty over the extent of the coronavirus and consumer behavior.
— Bob Zenouzi
For the past two weeks, our base case was that once the health scare fades, the economy might be set for a V-shaped or at least U-shaped recovery. Through the developments of the past few days, particularly the large-scale quarantines in Italy, the expectations that we might see similar developments and consequently a more severe hit on the economy in Europe and the US, together with the lack of strong orchestrated action from global central banks, has led to a reassessment of our view.
We now would not rule out a global recession, including the US. While the measures aimed at containing the coronavirus might help mitigate the problem from a health perspective, the damage is already done from an economic perspective, and more is to be expected. The additional price war in the energy market, in an already fragile environment, is worrying as it adds to the financial market risks.
Consequently, we are positioned more defensively. We would see the price movements as opportunities to re-enter risk markets if (1) there were bold, coordinated actions from central banks and finance ministries to support markets, and/or (2) the large-scale quarantines like the one in Italy end, for example, because a vaccine is quickly developed or the coronavirus stops spreading for other reasons.
Longer term, we still view the volatility as an opportunity in a market that was priced for perfection before, but we are monitoring the situation to get confirmation when it is time to act on the now more attractive valuations.
— Stefan Lowenthal
The views expressed were current as of March 10, 2020, and are subject to change at any time.
The views expressed represent the investment team’s assessment of the market environment and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.
IMPORTANT RISK CONSIDERATIONS
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