Stock markets have taken another steep tumble since my post last week. People say that the bottom of a market crash happens when everyone gives up, at the point of maximum pessimism. My emotions have taken a bit of a pounding too and I’ve started to feel the urge to capitulate. Maybe that means we are near the bottom? I fear not. I’m trying my best to remain level-headed in deciding the best course of action from here. This probably isn’t helped by the fact that my wife and I are locked down in self-isolation in our London flat with mild symptoms of the virus…
I hold up my hand to being slow to fully appreciate the severity of what is happening. The long bull market may have made me a bit complacent and my natural scepticism has led me to be overly dismissive of the economic risks posed by a mere flu-like illness. It just didn’t seem plausible to me that the unprecedented draconian containment measures we are now starting to implement across much of the world could be imposed for more than a few weeks if at all. I’m now appreciating that a longer duration is looking quite likely. The fact that the duration is undefined creates huge uncertainty. At the moment it looks like we could be about to sacrifice several £ trillion shutting down much of the global economy for several months to a year. Frankly, this seems a wildly disproportionate cost relative to the prolongation of life it might achieve for the mostly elderly victims of the virus. And that’s ignoring the negative health effects of a containment-induced global recession…
However, I can also see that it would be politically indefensible not to make this sacrifice in the current media-fueled hysteria, especially now that several countries have started down this route. It would take a pretty brave politician to not do everything in their power to ‘flatten the curve’ and prevent healthcare systems from being temporarily overwhelmed. The will seems to be there to put containment measures in place for much longer than I imagined possible at the outset.
I think longer lasting containment carries a high risk of extremely severe repercussions for the economy. China released numbers suggesting its industrial output fell by 13.5% and retail sales by 20.5% in January and February this year (and only part of that period was affected by its shutdown). Analysts from Goldman Sachs see US GDP contracting by 24% in the second quarter. To put that into context global GDP fell by around 4% in the Financial Crisis. The possible scale of the economic impact here is huge. It’s sufficient to tip economies into recession if containment lasts for just one quarter. If it lasts for longer the impact could be truly horrendous.
The longer the recession the more severe the knock-on effects on consumer confidence and business decisions. Decisions to make capital investments, like upgrading IT, could be delayed for a long time. This is probably what I am most concerned about given my focus on IT growth businesses. Sure, all my investments are financially stable and benefit from recurring subscription revenues but a lot of their valuation is predicated on future growth that may now be postponed. There may also be risk of financial contagion from bad debt and deteriorating credit conditions. I’m not sure this is such a big risk given governments seem prepared to step in and do whatever it takes to bail people out, but there are a lot of unknown unknowns. Finally, the extreme financial measures to protect jobs etc. that are going alongside containment look likely to be inflationary in the long term. I’m not concerned about this for now with the economy grinding to a halt, but it’s something to keep an eye on in the coming years when things pick up again.
That’s enough of the doom and gloom! Markets will recover from even the worst case scenario before very long and I don’t think you can go too far wrong by being patient and toughing it out. And there are lots of ways in which containment measures could end up lasting for a much more limited time than the worse case scenario. Greater testing may allow for more sophisticated and less disruptive approaches to slow the spread of the virus. Treatments (such as chloroquine) have been found effective in small scale studies, but will probably need more testing before they can be adopted. ICU capacity is being expanded. Hot weather is likely to significantly slow the virus and other natural factors also often lead to epidemics slowing down or becoming less virulent over time.
The market has already fallen by a third and I’d say is maybe discounting a recession from containment measures lasting a reasonably short time (perhaps a few weeks). I don’t think it has fallen enough to discount a severe recession from longer lasting containment. If this is really on the cards, and I think it might be, then it probably has quite a bit further to go.
My strategy is to remain fully invested unless I’m reasonably confident I have an opportunity to sell out and reinvest at significantly lower prices (at least 20%). I think there is a good chance that prices will fall significantly further from here leading to a better buying opportunity. However, I’m by no means sure. My plan is to push the big red button and raise a big chunk of cash tomorrow (around 1/3 of the portfolio), stripping back to the holdings I have relatively more long term confidence in. I plan to keep:
- Best of the Best
- Gamma Communications
- Games Workshop
- IG Group
- Ideagen (new holding – will write up soon)
- Monster Beverage
Obviously, I’m kicking myself for being slow on the uptake and not doing this sooner. However, it’s more important to look forward to the opportunities ahead rather than dwell on the opportunities missed. I might have to have a rethink about whether stop losses are a good idea after all when this is over. They certainly seem attractive right now…