BFI Infinity InSights: Coming Out of The Global Lockdown
The title of our February 2020 update was: “The year ahead: Expect the best, prepare for the worst” and we explained in our publication why we were cautious and advised investors to hedge their bets. While our main concern was a slowing global economy, the start of the corona pandemic added extra uncertainty and we clearly highlighted the risk of a stock market correction. Also in our February edition we looked at the potential impact of the developing corona crisis and while we certainly realized the potential risk, we did not foresee the enormous impact it would have on all of us.
BFI Infinity InSights
This article was published in the most recent Insights, BFI Infinity’s quarterly newsletter. To read the entire InSights Newsletter, click here.
Just in a matter of a couple of weeks, we saw the whole western world go into some kind of lockdown and borders were closed pretty much everywhere. The fact that we had hedged our bets could only give us a bit of comfort, as the pandemic had far-reaching consequences, the kind of which most of us have never seen before in our lifetime. Nevertheless, despite the widespread disruptions and business shutdowns, our company continued to operate normally. Throughout this challenging time, our investment positions were safe and so were our employees.
Most major stock markets reached a high around February 19. After that, the unfolding corona crisis was really starting to bite and within just 4 weeks, global equity markets tanked by 30-40%, falling into bear market territory. While in the beginning of the crisis the health risks were the main concern, very quickly people started to realize the enormous economic damage that would be caused by the world-wide shutdowns. Unemployment rates have since then risen sharply, especially in the United States, where many workers are on short-term contracts and live on weekly paychecks. There was never a time in the country’s history during which so many people lost their jobs. The picture in Europe looks better so far because typically workers are not getting fired as quickly as is the case in the U.S., but it is clear that the situation will worsen in the coming months as the structural damage across the economy is becoming more visible.
In the beginning of the crisis, all eyes were on Italy and Spain that were hit the hardest by the disease, with areas in Northern Italy, as well as Madrid, developing into pandemic hotspots. Initially, the outlook for the rest of Europe was also very bleak. It was projected that the pandemic would rapidly spread around the continent, potentially causing millions of deaths until the summer and there were warnings that most healthcare systems would collapse. I think most of us felt like we were in some kind of science fiction movie and everybody was surprised by how quickly the western world moved from “business as usual” to complete lockdown mode.
In the early phases of the lockdown, the harsh measures were well understood and largely accepted, but it wasn’t long before questions began to emerge regarding the restrictions that were enforced and a debate started about how long this global economic freeze could be realistically maintained. While the virus continued to spread in Europe and North America, the worst-case scenarios and fears have not materialized. Of course, it is very sad to see people dying, but during the last couple of weeks it was a relief to see that social distancing and other safety measures did indeed cause the spread of the virus to slow down. Now, most of Europe and soon the United States are re-opening their economies, businesses are getting back to work and very soon borders will re-open too. While some risks and fears remain with regard to a potential new spike in infections, it is good to see people getting back to their lives and their work, kids being able to go to school again and all of us starting to enjoy the freedoms we are getting back.
Financial markets also reacted quickly. In fact, stock markets started to bounce back in mid-March and at the time of writing, almost two -thirds of the losses caused during the corona sell-off have been recovered. However, the real economy will take longer to heal. The structural damage has yet to be seen and at the moment we can only estimate how deep the wounds will be. So far, the stock market recovery has been fueled by the enormous injection of liquidity coming from central banks and governments around the world, as well as the re-opening of all major economies. At BFI Infinity, we took profits on our hedges in mid-March and have since then participated in the recovery. However, in early May, we decided to add again equity hedges until mid-July, as we feel that the current recovery was too fast and has gone too far without taking into consideration the full extent of the economic damage that the
corona crisis caused.
The enormous liquidity injections by central banks around the world and the historic fiscal stimulus packages from governments will certainly help initially to get us through the worst part of the crisis. But the question that we all need to ask ourselves is: How much can we afford and for how long can we afford it? The discussion in recent weeks has been a polarized
one, with a deep divide between those who believe that it is too early to reopen the economy and those that think we need to get back to work as quickly as possible. Who is right and who is wrong? Is there even a right or wrong answer to this? In our view, there must be a way to achieve both goals, to protect our health as well as keep the economy going, because after all, a well-functioning economy is probably the biggest welfare- supporting system that we have today. While we do our best to protect our own health and to shield the most vulnerable people in our society, we also have a responsibility to move forward, keep businesses going, preserve jobs and maybe most importantly think of the generations to come that will eventually have to foot the bill and repay the enormous amounts of debt that are being created. Not considering these viewpoints is a huge mistake and would be unfair on those that got hit the hardest in this catastrophe.
It is our opinion that the coming weeks will present another test for markets, because the structural damage is only now becoming visible. The short-term momentum has improved as we are moving out of the lockdown mode, but we need to be realistic and understand that it might take a long time until the global economy is back to where it was before the coronavirus. Until then, many companies will face headwinds and subsequently corporate earnings are going to be very weak initially. Therefore, the risk of a renewed drop in equity prices remains high, especially in the next few weeks. While we are now generally hedged and hold a lot of cash, we approach the coming weeks in a comfortable but flexible position. We are ready to put more cash to work and increase our equity exposure, yet at the same time we want to have protection in place, just in case.
While the short-term outlook for stocks is more positivethan what we expected it to be, we need to bear inmind the wider impact of the crisis on other asset categories. Looking at bonds, we might have reached a40-year bottom in interest rates, as the whole worldnow has rates at zero or even in negative territory. So unless an investor is willing to accept significantlyhigher levels of risk, there won’t be a meaningfulreturn. This begs the question: Why would somebody still hold bonds or reinvest in new bonds? Thus, at this stage, we plan to hold the existing bonds we have bought at higher yield levels, but will most likely not reinvest funds in the fixed-income market for the time being.
In addition, low interest rates, record levels of liquidity and heightened global uncertainty make a perfect recipe for precious metals prices. The very positive developments in recent weeks might only be the start of a longer-term appreciation. We therefore remain positive on precious metals in the short term and we are bullish over the long term.
Even as the world now returns to a new kind of normal and as we enter the post-corona era, it needs to be understood that this crisis has revealed many weaknesses in our western society, our political system and our economy. In an ideal world, we would learn our lessons and we would be better prepared for the next pandemic, whenever it may come. However, there’s a risk that the crisis has had effects that will not be reversible. The European Union is a prime example of this. Although the situation in Italy is stabilizing, the economic damage is so extensive that it is already clear that the country will need much more support from the European Union. But as all countries in Europe are themselves dealing with the effects and aftermath of the crisis, will there be the political will and the practical economic capacity to support the weaker members of the Union? From this perspective, it seems more likely that tensions in the European Union will continue to rise, even after Brexit is eventually completed.
The situation in the United States is equally challenging. The country has produced deficit after deficit for more than 20 years now, and even when the economy was strong, the country was producing higher and higher debts. And what happens now? We are simply seeing a huge spike in terms of new debt being generated and at some point there is not going to be enough demand from investors. Ultimately, the solution could come from the Federal Reserve. After bailing out the corporate bond market, why not start buying government debt? Investors around the world need to realize that we are in uncharted territory here and that the most likely scenario will be an effort to re-inflate the global system by creating asset inflation. Of course, this has already been happening for many years, but we are now about to see it on a whole new level.
So what are the implications for investors going forward? In our view, bonds are not attractive anymore and over the long term, investors need to hold assets that will benefit from the attempt to re-inflate the global economy and financial system. High quality stocks and precious metals are prime examples of investments that stand to benefit.
With regard to stocks, we firmly believe that it is crucial to be very selective and pick sectors and individual stocks prudently. Diversification is always good, but investors need to be careful not to diversify at the expense of conviction. We like quality companies in sectors such as healthcare, technology, consumers staples and commodities just to name a few. We are also screening for so-called “supertrends” in the global economy, to detect strategic long-term value drivers and themes to identify attractive investments. This is not an easy process, but it should be clear to investors that at least for now, passive investing and simply following the market are not going to be effective strategies. While this will make it easier for the financial industry to sell products to their clients, it is certainly a great time for active investors and investment management firms with an active investment style. That is the camp we are in and we therefore appreciate the opportunity that the current environment presents, so that, together with our clients, we can continue to do what we have always done best: protecting and growing what is rightfully yours.
While our main concern in the past few months was to be careful, we should not forget to embrace life and the opportunities it is giving us. We hope you are well and stay well, and we wish you a wonderful summer.
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