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COVID-19: History does not repeat, but it does rhyme

02 April 2020

Our latest Wealth Management Wednesdays episode was a special edition focusing on the economic impact of coronavirus. Miles Berryman and Tammy Hall put forward their views on how the importance of investing with a long-term time horizon has never been more evident.

Before the spread of coronavirus really took hold, we were expecting another positive year for risk assets, with economic growth intact, a US-China trade deal in place and reports of encouraging company results. Our main concern at the time was the limited sector dispersion in returns, suggesting a large proportion of buying was at index level or ETFs.

Asian markets were the first to sell off, unsurprising given the trajectory of the disease, but global markets seemed more concerned at the time about the US-Iran confrontation. All this changed after the outbreak in Italy on 24 February, starting a market selloff that seems (to us at least) to have lasted quite some time, highlighting both the speed of the market falls and the virus spread itself.

We are in the midst of the fastest drawdown in history. The crude definition of a 'bear market' is a fall of 20% and the S&P 500 raced to this level much faster than any previous bear market. The aggressiveness of this drawdown is only approached by the falls of 1928 and 1987. The FTSE 100 was saved from recording its worst ever quarter by the last two days of March. US government debt has never traded with so low a yield, continuing to set records as the days go by. We truly are living in unprecedented times.

However, we are encouraged to see signs of a rational market. Markets appear to be distinguishing between different levels of risk, both at asset class level and within. Investment grade corporate debt has rallied markedly and we have seen a degree of sector dispersion within equities. Nevertheless, we wouldn't expect it to be smooth sailing from here. Large fiscal packages have now been announced and further announcements are likely to be at the margin. The wild card at the moment is Europe – Germany has already agreed to remove the constitutional debt brake and we are now waiting for the EU negotiations to reach their conclusion.

The adage regularly used in equity markets is that it is about 'time in the market, rather than timing the market' and here is why:

  • Volatility is normal: Every year has its rough patches. While these pullbacks can't be predicted, they can be expected; after all, markets suffered double-digit declines in 22 of the last 40 years. But, despite the many pull-backs, roughly 75% of those years ended with positive returns.
  • The length of equity market downturns is uncertain. Of the twelve S&P 500 bear markets observed between 1928 and now, the average duration was 22 months; the fastest recovery was three months and the slowest recovery 61 months. The fastest recovery was in 1987, which was also one of the fastest drawdowns and, in spite of the scale of the drawdown, the S&P 500 delivered a return of 2% by the end of that year.
  • Staying invested matters: For the 20-year period ending December 2018, an investor needed to miss only the best ten days of the S&P 500 market return to see their performance drop from 5.62% annualised to 2.01%. This differential may not seem large, but over ten years equates to 42.6% in return. And, we also can't be sure about the timing of the 'best' days – in 2015, the best day of index return was two days after the worst.
  • Emotional investment decisions can be costly: Looking at investor psychology, it is rational to sell into a falling market as it is to buy into a bubble. The issue is timing: buying before the rebound in market collapses, or selling before the peak in the case of bubbles. There is plenty of evidence however to suggest that timing the market is almost impossible. Research shows that, in any given year, a buy-and-hold strategy will outperform a switching strategy 92% of the time (not including transaction costs, which increase the risk and forgone return of switching anyway).
  • Diversification works: The last 15 years have been a volatile and tumultuous journey for investors, with multiple natural disasters, numerous geopolitical conflicts and the deepest economic recession in the post-WWII era. Yet, despite these difficulties, cash was among the worst-performing asset classes. Meanwhile, a well-diversified portfolio of stocks, bonds and other uncorrelated asset classes returned over 6% per year over the same period (and roughly 150% on a cumulative total return basis).

Our investment process seeks to capture companies with strong balance sheets and resilient business models that are able to generate returns over the long term. As we are diversified across sectors and asset classes, we are not making wholesale changes to our portfolios. However, we are poised to make changes around the edges, looking at the opportunities this volatility has brought, especially in technology. This does not mean the portfolios have not participated in market declines, but we are confident that, when this crisis is over, the holdings in the portfolios are well-placed to recover.

Ultimately, it is worthwhile to remain invested through gyrations in markets, despite fears investors may have watching the news. Risk assets deliver positive returns on an annual basis in the majority of calendar years, so investors are generally compensated for the risk they take. History does not repeat, but it does rhyme and we would not be surprised at any shape in the recovery from this market volatility. Although we are unclear about the duration of this disease and its effects on society and the economy, it would not be beyond the realms of possibility to witness a 1987-style recovery once the economy lifts again.