February Market Update

What is the headline risk? It is somewhat obvious, but the move of COVID-19 outside of China has shown that it has a higher probability of being a pandemic than it did before. The research we have reviewed shows that it is 20 times worse than the flu and can be transmitted much easier (not the best combination). We hear vaccines will be ready for trial in a few months, and there is growing confidence that one can be developed relatively quickly. However, it will get worse before it gets better.

How bad is this relative to history? Deutsche Bank produced the chart below showing that this drop is the swiftest on record.  However, let’s put it in perspective.  Though the drop has been quick, the ramp up in the markets was also speedy. 

So, we tend to look at the severity in terms of how much of past market growth has been erased by the drop.  As of last night, the drop so far is not that severe.  Keep in min that news organizations are going to feed panic for their own bottom line.  They have never been shown to be cool and calm in the face of market turmoil.

Have you changed your positioning because of it? We were defensive in advance of this event.  In September of 2019 we moved to a 40-50% cash position in our equity products and reduced equity exposure to 25% in our balanced strategy. Our multi-asset income strategy was positioned to have no equity exposure.  As a result of this event we have not added to our cash positions. The severity of this decline is high and the speed with which it occurred is unprecedented. However, the time to act was before the damage, not after it. Our models are not currently dictating additional changes based upon this week’s major decline.

What would make you move more defensive? We have discussed that the market was exhibiting too much greed with too much complacency. That is changing now. Fear is gripping global markets. To become even more defensive, we would need to see the market’s decline have measurable impact on global economic growth and the financial systems that supports it.

What would make you re-enter the market? Fear is taking hold and we do ascribe to Warren Buffett’s saying to becoming greedy when others are fearful. However, the other saying we take to heart is to not catch a falling knife. Balance, patience and rational thought are a long-term investor’s most valued attributes. We will be looking for stability in the debt markets and other elements that suggest that fear is overdone. We are not there as of today.

How have the strategies performed over the past week? Though we serve many different platforms with each having their own cost structures.  Below is meant as an approximation as these are representative accounts of internally managed funds (founders’ capital) net of fees.

In summary, we were defensive prior to current events. We did not know it would be the virus that would send the market down, but we saw early warning signs that greed and complacency were high, and stresses were building in the system. Market corrections happen and are built into historical market risk characteristics.  However, that observation can be neglected when the market drop happens as fast as it has.  Understand that our investment process is functioning as expected. At this time, the indications are for this to be a normal, albeit significant, market adjustment and not a structural issue as seen in 2008. However, our “ears are perked” and looking for new information that we can use to make a judgement as to the next phase of this correction.