As luck would have it, I was booked in to shoot a video with one of my favourite global equity fund managers last Thursday afternoon. When I turned up with the film-crew, the manager looked ashen-faced. He calculated that he was £140m down on the day. That he stuck to our arrangement and did the interview was a great illustration of how the best investors really are made of sterner stuff than the rest of us.
Apart from his good manners and robust temperament, what struck me most was this manager’s confidence. He said he was sure that in five years’ time we would look back on 12 March 2020 as one of the best buying opportunities of his career. I agree with him, for four reasons.
First, while it is clear that we face a significant economic hit from coronavirus, this downturn is different from the recession triggered by the financial crisis 12 years ago. While there will be a meaningful impact on both the supply and demand sides of the economy, the damage will be temporary.
Unlike in the Fukushima disaster in 2011, supply chains have been shut down not destroyed. The factories in the Pearl River delta are still standing. They just need their workers to return. In fact, as the infection rate in China drops off, the country is getting back to work. Near-real-time data like coal consumption and property sales are getting back to normal.
About 20% less coal is still being burned than in a normal March, but today’s figure is 25% higher than it was in February. Traffic congestion in Shanghai is higher than in the same month two years ago, although that may partially reflect a preference for self-isolation in a car than taking the risk of travelling on public transport. Property sales, which essentially stopped for a month around the New Year holiday are back to half normal levels.
My second reason for optimism is the speed of the market’s decline and its indiscriminate nature. It is sometimes said that the stock market goes up the escalator but comes down in the lift. A glance at a chart of the FTSE 100 over the past 12 months suggests a different analogy. Investors in the UK’s blue-chip index appear to have taken a distracted walk along the top at Beachy Head and kept going.
The drop into bear market territory for the S&P 500, at just 16 days for the 20% slide from the all-time high on 19 February, was the fastest ever, culminating in the biggest one-day drop since 1987 and the fifth biggest since 1928.
The speed of the fall is an indication of the sentiment-driven nature of the drop. When the market is making a rational assessment of future growth prospects it feels its way lower. Last week’s price action was different. This was ‘make the pain go away’ capitulation. The evidence for this irrational mind-set was the performance of gold and Treasury bonds on Thursday. When shares, precious metals and US government bonds are all being sold off on the same day, you know that investors are simply raising cash wherever they can.
The growth in importance of algorithm-driven trading is another factor in the speed and violence of recent market movements. The rise of passive funds has also played its part. Regulators might ask themselves whether they haven’t created a monster by encouraging investors into low-cost but price-insensitive investments.
The third reason to think that things have gone too far is valuation. Of course, any conclusions investors can draw here are necessarily tentative because we won’t know if shares are genuinely cheap, or only apparently so, until we have seen how long and deep the downturn in the first half of 2020 turns out to be.
My guide to insane valuations is a table in George Blakey’s History of the London Stock Market which shows the yields and price-to-earnings ratios of a handful of leading British shares on 6 January 1975, the bottom of the most savage bear market any investor still alive has experienced. ICI traded on 3.5 times earnings and offered a yield of 14%. That was positively expensive compared with Grand Metropolitan on 2.4 times earnings and a dividend yield of 20%.
When I looked through today’s equivalents at the end of last week, I found 14 FTSE 100 apparently delivering a double-digit dividend yield while 27 of the blue-chip index’s constituents were yielding more than 7%. Clearly not all of these dividends will survive the economic shock that coronavirus might serve up this year, but I cannot recall a time when more than a quarter of Britain’s biggest shares offered such attractive income.
The final reason to think that an investor with a medium-term time horizon will not regret getting back into the market at today’s levels is the fact that the elements are in place to fuel the next upward leg. First, I suspect the coronavirus outbreak, the highly emotive response to it and the extreme measures taken to contain and delay it will have a significant structural impact on the way we live our lives. Working from home will be normalised and our lives will move ever more online, from shopping to entertainment and communication. There will be some big winners and successful investing will in large part be about spotting them.
In addition, cheap oil, expansionary fiscal policy and even easier monetary policy all over the world will provide a firm platform for rapid economic recovery in the second half of this year and beyond. Markets will start to price this in long before it is evident in the numbers. The best time to invest is not when you see light at the end of the tunnel but when the darkness is a shade less black.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.