Coronavirus is a good example of how even the most thorough macro narrative can be blown out of the water. A human catastrophe first, but it has also shocked markets because it will reduce economic growth – although by how much remains to be seen.
How can we cope with something so unexpected? The first answer is thorough risk management and maintaining the right level of diversification, which has become more difficult after the huge decline in bond yields in the last twenty years. The advantage of multi-asset approaches is they can diversify, but getting it right requires discipline and expertise.
The second is to be active and flexible, able to adapt to sudden changes. Even before the virus shock, we had been increasingly concerned about frothy sentiment. Our strategy’s equity protection and government bonds provided a cushion as markets deteriorated.
The third answer is to have a disciplined investment process that can properly assess the impact of an external shock. A consistent and rigorous framework can help avoid getting swept up in panic.
We’ve had a pretty consistent longer-term view: the world is in a “muddle-through” environment where trend growth remains subdued. In 2019, a trade-war-induced manufacturing recession brought growth below its long-term trend. We started 2020 optimistic that the end of that recession and loose monetary policy would see growth return to trend, but that heightened valuations and increasingly bubbly sentiment would act as a speed limit on asset prices.
Much of that outlook remains intact. Policy remains accommodative and stable. Sentiment and valuations are still elevated. The key impact of the virus will be on fundamentals: as expected, data has been improving as we start the year, but the virus will have a significant impact on China and hence regional and global growth. It’s unlikely to be enough to cause a global recession, but the extent of the impact won’t be fully known for months, if not longer. Investors must cope with an uncertain fundamental picture for a while.
What does this mean for our strategy? It pays to be dynamic in this environment. We reduced risk sharply in the middle of January, driven by what we saw as increasing market complacency. This helped cushion the strategy in the downturn, after which we returned to a more neutral position. Over the longer term, we are minded to add exposure to risk assets, but until the fundamental picture becomes clearer, we remain cautious.
Even after the narrative has moved on from the virus, we remain in a febrile late-cycle environment which will continue to see sharp swings in markets. In alternating periods of feast and famine, an active and flexible approach can make all the difference to outcomes for our clients.
Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than you originally invested.