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COVID-19: THE PIN THAT POPPED THE BUBBLE

Global equity markets delivered the best calendar-year return of the decade in 2019. Many markets were at or near all-time highs. Foord Singapore portfolio manager BRIAN ARCESE looks at the market’s dramatic fall from grace.

Welcome to 2020, already the most volatile period in modern investing history. We know this because the VIX tells us so (Chicago Board Options Exchange Volatility Index). 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 20% in just 20 days. During the global financial crisis in 2008, 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 9% for the first time since October 1929.

The media has inundated us with COVID-19 reporting. We all know that the pandemic caused the market rout. But we didn’t know it was coming. Donald Rumsfeld would call it an unknown unknown. 

Let’s momentarily cast our minds back to the pre-pandemic economic environment. The world was still an unpredictable place as we turned the decade. Yet 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 GDP growth.

In Europe, the United Kingdom had finally withdrawn from the European Union. Formal withdrawal after 1,317 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 three times successively. The loose monetary conditions and persistent real wage growth augured well for an improved 2020. Markets as we have written were on lofty valuations. Barring a material unknown unknown, the chances of a US recession and market rout were therefore low.

Then, in early January, the media reported on a severe new flu emerging from Wuhan, in China’s Hubei province. Commentators drew quick parallels with the 2003 SARS epidemic. To limit contagion, the Chinese authorities resolved to quarantine first Wuhan, then Hubei and lastly much of China’s 1.4 billion population. With hindsight, this action was not quick enough. 

Foord’s global investment team sits in Singapore. The city state recorded its first COVID-19 case on 23 January. Today, the infection has spread to millions of confirmed cases in 192 countries and territories. Over one hundred thousand 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 (like 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 Foord’s global fund managers time. 

In January, we increased portfolio hedging in the flagship Foord International Fund. The fund’s positioning was already conservative. We hedged more in February. For those with technical knowledge, we bought put options on the S&P 500 index and sold S&P futures. The Foord Global Equity Fund had less exposure to the expensive US markets than peers and global stock indices – it has fared better than most global equity funds.

The market rout began in earnest in March as the virus began to spread globally. Industrial commodities and oil were inevitable 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 has limited Foord International 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 also 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, especially 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 mankind’s response was most damaging to society.

With volatility comes opportunity. However, it would be incautious to load up with risk assets when the economic trajectory is still so speculative. The hedges in the Foord International Fund therefore still guard against further market weakness. 

Foord’s funds thus remain conservatively positioned and balanced. They are not reliant on one outcome. Many quality long-term investment opportunities are now suddenly attractively priced. Your fund managers will not squander the opportunity. But we will deploy cash warily and wisely.

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