John Townsend’s Investment Opinions June 2020

Intelligent individuals learn from everything and everyone, average people from their experiences. The stupid already have all the answers.” Socrates

The financial crisis started by the reactions to the global Coronavirus pandemic calmed down as quickly as it started. The panic which caused investors, both institutional and retail, to attempt to sell every asset that they had irrespective of price, ended almost as quickly as it began with institutions in particular emerging blinking into the cold light of reality. The sentiment that caused massive panic is now working the other way and combined with government support, is causing investors to re-invest. This is often called a ‘bear market rally’. The major problem here is that such sentiment is fragile and could easily turn negative again. If as expected, a second wave of corona infections emerges at the end of the summer, prices will fall again if a second pandemic surge becomes apparent, but they will then resume their slow and laborious path upwards.

While many equities have recovered strongly, some bond-based assets still have a way to go because interest rates have now dropped to zero and below. The frothy levels of 2019 will probably take at least two years to be reached again. In the meantime, nervous investors will encounter more shocks in the months ahead and may react with less fear than before but will none-the-less feel inclined to sell some of their assets. Long-term investors could use this phase as a time to buy at the lower prices.

The crisis has treated many geographical areas differently. Developed Asia saw a disciplined reaction to the pandemic and is now recovering.  In Europe, the systems which had been developed to manage pandemic risks failed and internal and external geographical borders were closed. These systems will have to be reconstructed, especially as the virus which caused so many deaths has not been defeated. The reaction in the USA, dependent as it was on the whims of one man seeking to adjust the facts to aid his re-election, was tragically too little too late.

In the meantime, in order to support the economies and to prevent the economic collapse of banks and system relevant employers, western central banks and their governments have announced massive debt increases. This largesse will be passed on both in the form of outright grants and soft loans. Whether this will be enough and indeed whether the right targets will have been hit by this support remains to be hoped for.

Globally the world has already seen over 400,000 COVID-19 related deaths. This figure is probably too low, as some countries are simply lying about their figures for political and doctrinal reasons or not recording the deaths at all. The death toll will undoubtedly rise as political buffoonery in the USA, some parts of South America and indeed the United Kingdom continues unapologetically unchecked.  A study from Imperial College London suggests that the overall European death toll without a severe lockdown would have been at least 3 million higher. The virus will in time be controlled, but never eliminated. A vaccine is hoped for and is being worked towards but is unlikely before the end of 2020.

While the equity markets have begun to recover, the initial recovery phase is partly a recognition that the markets fell too far too fast during the first wave of the crisis in March 2020. The deepest point of the financial collapse was 23rd March, but the political reaction in the USA was initially based on the hope that the problem would miraculously disappear if ignored for long enough. Even now it is unclear what US government policy is actually going to be.

The US Federal reserve has advised that it sees a need for an increase in debt of up to 3,000 Billion US Dollars, but the recently announced unemployment figures which were much better than expected, might cause a revision in this figure. These statistics themselves are open to doubt. The US has a history of revising statistical data after they have been announced and the headlines have been made. The present figures seem to be politically supportive of the present president.

The European Central Bank, under the headline TINA (There Is No Alternative), has devised a plan to provide 1,250 Billion Euros of support to financial markets across Europe. The ‘frugal’ states, Austria, the Netherlands, Sweden and Denmark might still block or reduce the package, but their governments are acutely aware of the crisis facing the region. This is no time to be bashing Greece, Italy, Hungary or the South-East European states.

With so much more debt hitting the markets, there is a massive oversupply of debt obligations, just as interest rates are either near Zero or in some cases negative. Some institutions, especially pension funds, will have to invest in this paper, because they have no choice under the terms of their trustee agreements. Others will switch to the Equity markets. The dependence on skilled credit analysts to distinguish between healthy companies in different sectors and ‘zombie’ companies kept alive only by high debt levels has become acute and will be ever more so as high yield debt investors look for positive returns for their portfolios. There has been nothing in the last 30 years with which to compare the current position. Analysts will need to become original thinkers!  Average corporate earnings in the US appear to have fallen some 20% since the crisis began, but investors should be warned that this seems to be a ledge stopping the fall and could crumble if there is a second wave of the pandemic.

The COVID-19 virus (or Coronavirus SARS-CoV-2 to give its official name), neither knows nor cares whether states or individuals take precautions against it. The odds of a second wave are at best 50:50, whichever way one looks at it. A second wave will be met with the experiences that society has gained form battling the first wave, so the reactions will probably not be quite so strong.  The effect of a second wave will however be to slow an economic recovery. Many announced governmental measures are designed to show willing rather than meet a real economic need. The announced 6-month reduction in VAT or ‘Mehrwertsteuer’ by 3% in Germany will in truth have only a minimal effect, but it looks good.

There will be enduring changes in global economic development, which will cause the recovery to take longer than hoped for. The Chinese economy has reopened for business, but with a politically rather than economically motivated trade war restarting before the next US presidential election, there will not be any great advance in activity there or benefit to global trade. The world has treated China relatively gently in past years, in the hope of gaining some economic benefit. This has now stopped and Chinese companies such as Huawei will face very close scrutiny.

Banks as a whole will need to become more efficient. One recent estimate suggests that up to 20% of global bank jobs will disappear altogether with digitalization replacing some 40% of the administrative positions. This will undoubtedly cause unhappiness amongst the inefficient German banks which are in any event under pressure to merge.

The European economic recovery, even without a second wave, will be affected by the realities of domestic life. Some people will have to stay at home, because the schools have not fully reopened and someone has to look after the children. The ‘new normal’ will have to wait for reality to take over.

Some companies, such as the German car builders and other engineering companies will need to reflect on the reduced demand for their existing products and consider how to attract new customers.

The press and many pundits suggest the shape of a recovery in terms of letters of the Alphabet. A ‘V’ shape, where prices rise as sharply as they fell is unlikely. A ‘U’ shape where prices rise sharply after a pause for reflection is also unlikely. Then there is an ‘L’ shape where prices do not rise at all following the fall in prices. The potential for a second wave could, it is suggested, cause a ‘W’ shape. It is comforting to describe future movements in structures that we know, but I do not think that any letter of the alphabet is helpful here. It is my belief that the panicked fall in the investment markets which reached its base on 23rd March 2020 was followed by an immediate uptick when investors realized that they had gone too far. The future is likely to show an upwards trend, which will be subject to periods of negative movement on occasions. The upwards line will remain neither steep nor straight.

Those clients with cash on deposit also need to be careful. A number of German banks, reacting to negative interest rates from the central banks, are now charging or planning to charge their clients, penalty interest rates on cash deposits over a relatively small level. For clients with a longer-term view of their investments it does simply not make sense to keep large cash deposits. There is no need to invest in the higher risk equity markets, there are many other alternatives to consider.

Overall, we will undoubtedly see more volatility in the investment markets. I try to reduce the impact of this as much as possible, but in many cases, volatility will be double the levels of previous years.

My portfolios will remain strongly invested in equities. How strongly depends only on the risk propensity of my clients. In truth there is now no alternative to investing in equities. There should be more encouragement of monthly regular investments, as cost averaging helps to reduce the volatility in a portfolio.

Past performance is no guarantee of future profitability.

John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung. He is a Fellow of the

Chartered Institute for Securities and Investment in London. (