Flash Update

At the risk of overloading your inboxes with even more market information, we would like to reach out and give a short update on the current situation.

The supply-side shock that happened after the coronavirus outbreak in China and other countries in Asia has been compounded by a demand-side shock when Italy and other countries outside of Asia began reporting large case numbers. This was followed shortly thereafter by the breakup of OPEC+ when Russia refused to cut production to support oil prices and Saudi Arabia launched a volume war. The confluence of events have led to a fear of deterioration of financial conditions. Recall that macroeconomic numbers were very strong in the first few weeks but this has been obscured by the negative sentiment and, more importantly, the mechanisation that has seeped into financial markets over the last several years.

One can argue that a large correction should not surprise anyone as the US stock market longest bull market has finally ended. What has astounded market veterans is not the size but the SPEED of the correction. In a marketplace where giant ETFs, algorithmic traders and even AI-driven houses trade alongside active investors, a dramatic shift to “risk-off” feeds on itself. ETFs are forced to sell which constrains many investors from holding onto positions that traditional growth and value investment managers can choose to do. Even the term “risk-off” is a relatively recent term, describing a situation that signals investors to make wholesale exits from risky positions, oftentimes indiscriminately. The feedback mechanism amplifies over and over through market mechanisation. Security prices get written down by even a small number of trades and even the most level-headed investors get caught in the maelstrom.

Is there now a disconnect between asset prices and macro fundamentals? Very likely. Conditions are not close to 2008 but the market has certainly behaved like it’s 2008. G7 interest rates are close to zero and central banks are resolved to establish a floor for their respective economies’ footing. Governments are scrambling for appropriate fiscal stimuli and intervention, especially those countries where there is no room left for monetary policy to be effective.

There is no doubt that Italy, the rest of Europe and the US will feel pain. Lockdowns, cancellations, lost wages will have serious medium-term aggregate pain to households and businesses as economic activity slow down to a standstill. But we will restart! China is on the road to normalisation with increased domestic air traffic, reopening of (albeit understaffed) workplaces and patient discharges outnumbering new cases. The supply shock will subside as production restarts and supply chains get repaired and more diversified. It will take time but the rest of the world will restart. Some weak companies will not survive as their compromised balance sheets prevent them from financing their operations. But well-run, prudently-levered businesses will survive. Theme parks will reopen. Airlines will resume flights (with perhaps even cheaper jet fuel). Biotech and pharma will profit from ongoing research and development. And households will keep buying goods and services.

Korean stocks are now trading at 0.77x book value, Hong Kong at 10.7x earnings. We remain wary and will eschew certain sectors. But assets that we thought were way too expensive a few weeks ago are starting to look like oversold bargains. Our clients’ financial objectives have not changed. As we seek to protect value, we must keep an eye on growing that same value so that it can enable and sustain our clients’ desired lifestyle and future spending. That entails a good offense to go along with good defense.