Last year, global equity markets delivered the best calendar year return of the decade. Many markets were at or near all-time highs. Fast-forward a quarter, and 2020 is already the most volatile period in modern investing history. We know this because the Chicago Board Options Exchange’s CBOE Volatility Index tells us so.
In three short months, global markets have broken record after record. None of them pleasant.
The S&P 500 recorded its fastest transition from bull to bear market. The benchmark US stock index succumbed 20percent in only 20 days. During the global financial crisis, it took 274 days to enter bear territory.
The median length for all bearish drawdowns since 1915 is a sluggish 156 days. The index also posted three consecutive daily moves exceeding 9percent for the first time since 1929.
We all know that the pandemic caused the market rout. But we didn't know it was coming. Donald Rumsfeld, a former US secretary of defence, would call it an unknown unknown.
In the pre-pandemic economic environment the world was still an unpredictable place. As we turned the decade much of the geopolitical uncertainty of 2019 had begun to abate. The signing of phase one of the US-China trade deal in January was encouraging. Full accord would, of course, need more and difficult debate.
But the world’s economic powerhouses seemed to have passed peak trade uncertainty. Removing this economic headwind would add meaningfully to US, Chinese and world gross domestic product growth. In Europe, the UK had withdrawn from the EU. Formal withdrawal after 1317 days of relentless and fractious debate marks only the beginning of a transition period. London and Brussels must now hammer out the details of their future relationship. But business could finally begin to plan and invest.
In the US, the Federal Reserve had cut interest rates successively three times. The loose monetary conditions and persistent real wage growth augured well for an improved 2020. Markets were on lofty valuations. Barring a material unknown unknown, the chances of a US recession and market rout were low.
Today, the infection rate approaches
1 million confirmed cases in 192 countries and territories. Nearly 50000 people have perished. Governments have quarantined one fifth of the world’s population. All these statistics will inevitably worsen.
It is self-evident that investment markets are forward-looking. But investors’ reaction to the global contagion was mostly coincidental, perhaps because of a grave misunderstanding that regional efforts would restrict the virus to Asia (such as Sars in 2003), or because the human mind struggles to understand and value large unknowns.
Whatever the cause, the lag in the market’s response gave investors worried about valuation risk time to hedge their portfolios. Some of us were already partially hedged. We took the opportunity to add more protection. But not all fund managers were worried. The evidence is in the wide dispersion of mutual fund returns.
The market rout began in earnest in March as the virus began to spread globally. Industrial commodities and oil were casualties of the expected economic slowdown. The Russia-Saudi Arabian oil price war added to the panic. The market declines have been painful for investors. But we are grateful that our decision to protect investor capital limited our fund’s drawdown to less than half the market’s decline.
There is widespread debate about Covid-19’s virulence and fatality. Confirmed cases and fatality rates vary markedly by country. It is improbable that different populations have inherently different resilience. The differences are thus due to testing protocols, reporting standards, quality of care and timing. Population age is a known differentiator in mortality rates.
Quarantines and travel prohibitions will slash global economic output in the first half of 2020. There will be recessions. These will cause millions of job losses, particularly in service industries. Governments and central banks have responded with massive liquidity and fiscal packages.
The goal is to shore up global markets and allow wage earners to fund daily necessities. But there will be many corporate failures and personal bankruptcies. History will judge whether the virus itself or humankind’s response was most damaging.
But with volatility comes opportunity. We think it would be incautious to load up with risk assets when the economic trajectory is still speculative. But many quality long-term investment opportunities are suddenly attractively priced.
Brian Arcese is a portfolio manager at Foord International Fund, Foord Asset Management (Singapore).
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