CEO Market Perspective
In the eye of the storm, it’s important to keep active, says Rob Harris, Majedie CEO.
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We would like to provide a brief perspective on this month’s global equity market falls. In what can feel like febrile market conditions, we believe that deep fund manager experience, a liquidity advantage borne from capacity discipline and an investment process founded on fundamental research, are especially valuable assets for long-term investors.
Firstly, a few market indicators. Since the market peak on 19 February, the S&P 500 index has lost close to a third of its value. The US energy sector has suffered a bruising 53% collapse, which speaks to the fragilities of a domestic shale gas industry suffering the additional burden of an ill-timed oil price war. The US 10-year Treasury yield has hit an all-time low, but since then bond markets have also shown tell-tale signs of stress, no doubt provoked by a combination of inflationary fiscal policies, the impending flood of new issuance, and forced investor selling. Market historians have had to revise benchmark comparisons on several occasions against which to measure the speed and scale of the stock market downturn. After suffering the worst week since 2008 early in this episode, there have been days when US market circuit breakers have kicked in and daily losses have eclipsed even those seen in the precipitous falls of 1987. Fears over the eventual spread of the COVID-19 coronavirus outbreak abound, with investors understandably uncertain about its full macroeconomic, sectoral, company-specific and, of course, social impacts.
At this late stage in the market cycle, following a powerful economic expansion and the longest equity bull run in history, volatility is absolutely to be expected. The elastic of valuation dispersion has been stretched to record levels and the performance of some concept growth stocks has been reminiscent of the heady days of 1999. Widespread investor complacency about the omniscience and omnipotence of Central Banks has been eyebrow-raising, to say the least. The value of global non-financial corporate debt outstanding today surpasses all previous peaks. That said, we believe there is a newer factor at play here, that of market structure.
One striking feature of this market correction is the accompanying deluge of traded volumes. When markets started to roll over in late February, the notional traded cash equity volume in the US reached record levels, with trading overtly led by mechanised strategies. US ETFs comprised approximately 40% of volume on 27 February, for example – on the market’s weakest day of that week. Equity trading volumes have rivalled those of the financial crisis in 2008 and also 2011; a time when markets were gripped by the fear of European sovereign debt contagion and Standard & Poor’s had downgraded America’s credit rating from AAA for the first time since 1941.
The popularity of passive, ETF and quantitative strategies over recent years means that more money is now being managed by machines than ever before; the failure of quant risk models in 2008 seems long forgotten. We believe that many of these strategies are in some way informed by price momentum, which itself has been a powerful performance factor over the past decade, with liquidity so abundant. Thus shares that have previously performed well in turn attract new investor money, with the reverse also true. A change in overall market regime may introduce a different trend, at which point buyers of popular shares may become sellers, and vice versa.
What might be the catalyst for a change in market regime? The precise cause (in this case, the coronavirus) isn’t always easy to spot in advance, but given recent shifts in market structure this may be increasingly less relevant. Machines don’t need to consider the merits or otherwise of pro-cyclical investment decisions, such as ‘selling on red’; they just sell. At the same time, overcommitted investors tend to deleverage, risk parity funds to adjust and backward-looking risk models to recompute. If the broad investor response to the COVID-19 outbreak is to take markets down to a level where trend-following machines then reset from a ‘buy on the dip’ to a ‘sell on the bounce’ strategy, then the market rotation die may already be cast: popular shares may be cast aside while cheaper, unloved shares may start to perform rather well.
At our 2017 client conference, and in other communications since, we cited a statistic from J.P. Morgan which calculated that fundamental active managers now account for only around 10% of European equity market traded volume; the rest is being driven by more mechanistic flows. This of course raises questions around price discovery but also throws up opportunities for those managers able to step back from the fray, to consider the next phase of the market cycle and adjust portfolios accordingly.
The spread of the pandemic has led to unheralded and dramatic social distancing policies, which are having profound economic consequences. The lockdown of an entire country is hard to fathom. Yet at such times it is important to keep clear minds and remain alive to the facts on the ground. As ever, we remain focused on what we do best – analysing companies, engaging with management teams, redoubling efforts to check and recheck our work, and positioning our portfolios for the best potential long-term outcomes for our clients.
In recent days, policy makers have started to dig deep to cushion the potential long-term effects of this pandemic. Overall, the combined monetary and fiscal responses in the US, the UK and Europe appear to be sensible steps at a time of uncertainty. Important and sometimes painful lessons have been learned since the last major financial crisis, one of which is when you need to act, act quickly and decisively. While markets remain rightly cautious – and there will no doubt be policy mistakes along the way – recent announcements should provide some assurance that when peak risk has passed, policy makers have an eye to ensuring the economic machinery can get back on its feet quickly. As would be expected, we are watching developments closely.
Where we consider that stock specific price moves have created opportunity, we have viewed the recent weakness as an opening to add judiciously to positions in companies which we believe can make money for our clients, responsibly, over the long-term. We have witnessed an event-driven market fall, but are acutely conscious of the cyclical and structural factors at play too.