From civilisation to anarchy – seven loo rolls
12 March 2020
An old Spanish proverb states that the difference between anarchy and civilisation is seven meals. Today it seems the difference is seven loo rolls, says William Dinning, chief investment officer at Waverton Investment Management.
We have seen panic in the supermarket and we have seen it on the trading floor. While Tuesday 10th March gave us some respite there was some extreme price action on Monday 9th March. It wasn’t just the fifth largest % decline since World War Two in the US stock market. Two-year UK gilts traded at negative yields for an hour that morning, for the first time ever, and the FTSE All Share traded with a dividend yield 25 times that of the ten-year gilt.
Markets are discounting a lot of bad news. Some of that bad news is likely to come to fruition. This deflationary shock to the global economy will see sharp declines in activity across Asia, Europe and North America with knock-on depressing effects on corporate earnings. Some corporates will struggle to survive without government aid given the hits to cash flows for those in many industries. These include not just those involved in the travel industry but also oil producers in North America after the collapse in oil prices on March 9th. In addition, we must remember that the supply disruption from the shutdown of much of the Chinese manufacturing base does not just impact technology companies. Spare parts for many industrial companies will be in short supply, as could pharmaceuticals in the US given the majority are made in China.
It is also possible that other western countries will have to follow the example of Italy and impose draconian restrictions on travel. The hit to economic activity will take another step down if that happens. So things can definitely get worse before they get better.
But all that matters to us professionally is to look at financial market prices and determine whether there is value. We have begun to make judgements on that question. We outline below how we are thinking about the direction of travel at this point.
First, we urged the reduction of duration in fixed income portfolios on March 9th. We would expect the direction of travel to be toward further reductions in duration.
Second, the relative attraction of equities to fixed income has become even more extreme in recent days. We highlighted the gap between the dividend yield and the gilt yield above and while the bad news to come likely includes significant dividend cuts, particularly in the industries most impacted by recent events, the equity market remains the better bet for the long-term investor at today’s price. We expect the direction of travel to be toward increasing equity exposure. Initially that might be in defensive plays. But we also suspect that just as the virus crisis began in Asia it will begin to end there which suggests adding exposure with an East to West trajectory for those with higher risk tolerance.
Third, the collapse in yields on the last remaining bastions of positive interest rates, the US and UK, means that alternative sources of income are needed more than ever. We have good in-house collective solutions. We also have recommendations on a lot of their component parts if buying fund(s) is impossible.
In short, this too will pass. Opportunities already exist for the adventurous long-term investor.
It used to be said that the time to buy is when there is blood on the streets. Perhaps in the 21st century the advice should be to buy when there is dust on the shelves.
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