Coronavirus: how should investors handle the biggest macroeconomic shock of all?

History tells equity investors to persevere in deeply unsettling times, writes Tony Yarrow.

For markets and investors, the Covid-19 epidemic represents an extreme liquidity event. Virtually overnight, companies are losing a large proportion, and in some cases all, of their income, while their expenses continue to accrue. 

The challenge is sudden, extreme, shocking and potentially fatal. Governments have rushed out measures designed to preserve economies and companies through an unprecedented period of shutdown. 

Despite the vast scale of the rescue packages, their scope is limited to helping companies survive, but are no substitute for the freedom to trade normally. No one knows how long the shutdowns will need to last, how long it will take to return to normal, and what business may be permanently lost in the process.

Familiar patterns?

In the stock market, companies with high levels of debt and in the most-challenged sectors (non-food retail, leisure, transport, hospitality) have seen their share prices collapse. This would appear to be a rational response to the total disruption of their business models. More surprisingly, other “value” sectors, such as financials, have been “shot to pieces”.

Over the past decade, a succession of macroeconomic shocks (the euro crisis, oil price slump, Brexit, trade wars, etc) have provoked a flight to quality in the financial markets. It is therefore no surprise that coronavirus – the biggest macroeconomic shock of all – has provoked a similar response, but on an even bigger scale. This pattern has paradoxically left safe assets so overvalued as to be no longer safe – however, those investors who have prudently avoided them have not been rewarded for their prudence.

In the panic of the last couple of weeks, another pattern has emerged. The price of gold, normally a reliable safe haven, has been volatile. Meanwhile, the price of normally-reliable UK gilts has fallen too – a rational response to the likelihood of huge new issuance by the UK government.

The UK property unit trusts have also been gated again. It seems that investors are now so desperate to raise cash that they will do so by whatever means they can. We shouldn’t lose sight of the extraordinary nature of what’s happened in financial markets over the past month. It is extremely rare to see such utter capitulation. 

The only way to explain the valuation of so many shares – some of which we own – is by saying that no one wants to own them. Times such as these are deeply unsettling. However, if we are able to get by without selling our investments, then we should do so. That way we don’t crystallise our losses.

Another example of history repeating?

It’s worth remembering that after the dramatic capitulation of 1974, precipitated by a banking crisis and the failure of a number of banks, the stock market regained almost 200% in the following year. 

Of course, no one knows what will happen next, but it is possible to make two guesses.

The first, which has already begun to happen, is that governments everywhere will follow Italy’s example and impose a more comprehensive policy of social distancing, which could cause new first-wave infection and death rates to peak earlier than expected.

Second, governments and central banks are now in “whatever it takes” mode. There is a desperate need to calm the financial markets, and that will happen only once the authorities have convinced investors that they will prevent Covid-19 from cutting a ruinous and permanent swathe through their economies, leaving millions of unemployed people in its wake.

The “whatever it takes” approach worked in March 2009 with QE, and again in June 2012 when Mario Draghi, former president of the European Central Bank, first used the phrase. The sense that an effective lockdown, together with generous and targeted fiscal policy, could both shorten and sweeten the coming pain, might be what is needed for the tide to turn.

Tony Yarrow is co-manager of the Wise Multi-Asset Income Fund.