As the world grapples with a global pandemic, our country and our world face a difficult time.
There is a tonne of commentary on Covid-19, mainly from non-experts who haven’t got the foggiest idea what they’re talking about. So, I won’t add to that drivel. I have no expertise in international public health. So, my comments are entirely from the perceptive of a student of history, liberal capitalism and the capital markets.
Over the last few days, stock markets across the world fell, recovered briefly and then fell again. At the time of writing, the FTSE All World Index, a collection of 3,000 of the world’s largest companies fell 20%. Think about that for second: a basket of the best and the brightest companies in the history of capitalism are now worth about 20% less than they did a month ago!
After over a decade of virtually uninterrupted advance, the global stock markets are officially in bear territory. I know that this bear market feels very different to the other ones; however, in many ways, each bear market always feels very different than the last. This one doesn’t feel like the 2008/09 GFC, which felt very different to the tech bubble of 2000 and all the other bear markets before it.
We talked about this?
The reality is, this type of decline in the capital market is a feature, not a bug. It’s part and parcel of investing. While no one could have known or predicted the exact trigger for the most recent decline, over the past few years, we have prepared ourselves and our clients for this. It may look and feel different but the latest decline, so far, is very well within the range of historical scenarios.
We have written and spoken on several occasions in the past few years about the need to stress-test your financial plans, based on a wide range of scenarios including one that accounts for several bear markets along the way. We knew that the market decline was only a matter of when, not if. We had no way of knowing, of course, that it would be precipitated by a global pandemic or when it would occur.
This is no time to make drastic changes to your investment strategy, jumping off the ship in these turbulent waters will only cause more harm than good.
How long will the current bear market of 2020 last? And how deep will it fall?
I have no idea. Neither do you. And that’s totally fine. If it’s any comfort, the average bear market for UK Equity lasts 20 months and bottomed out after a 37% decline! So far, we are c30% down, and it’s only the first month. We could be heading for a long painful winter but then again, how should I know?
Early signs suggest the current bull market has been faster than the previous ones. There is some evidence to show that the speed and depth of market declines correlates with the speed and depth of the subsequent rebound. Eminent financial historian Prof William Goetzmann (Yale University) examined what happens after serious market declines in a comprehensive study that spans over 100 global stock markets over three centuries. He concluded:
‘We identify 1,032 events for which a market declined by more than 50% over a 12-month period. Conditioning on these events, and controlling for a range of other factors, we find that markets tend to rebound in the year following the crash. We refer to this pattern of crash-and-rebound as a “negative bubble.” Interestingly, the pattern only holds for large crashes – declines of lesser magnitude exhibit persistence, not reversal.
‘Using a large sample of 101 global stock market indexes extending over four centuries and encompassing most of the world’s identified stock markets, we find several things. First, crashes of great magnitude are rare. Despite their rarity, they are potentially interesting. A decline in asset values by one-half is frightening to investors, disruptive to the financial system and may indicate a major change in market expectations about future returns and risks. It may even represent an existential risk to the market. Investors are rightly concerned with major crashes, although they typically overestimate the probability of one.
The probability of a large positive return is higher following a decline in the market of at least -50%. Returns following a severe crash are on average more than 10% higher than those following a market gain. We also find some evidence in our broad sample that more modest crashes exhibit the opposite dynamic. Declines on the order of -10% to -20% are more likely to be followed by another decline. This pattern is not consistent in the data and is not present in a sub-sample of 41 major markets that does not include many of the markets that appeared since the mid-1990’s.
One thing that virtually all bear markets have in common though is, they eventually come to an end. This too, my friends, shall pass. And when it does, the capital markets, not just here in the UK, but around the world will resume its permanent advance.
But how?
I know there’s a lot of fear out there (mainly driven by the mainstream media). There are doubts over the different approaches taken by governments around the world. There are serious concerns over the likely impact on families, jobs and our collective way of life. Subsequently, there is a fair amount of doom-mongering, predicting the end of life as we know it. This is only human.
Other than my reliance on the weight of history, I have no idea exactly how this might turn out. What I do have, is an unflinching faith in our collective ingenuity as humankind – expressed through science, art and capitalism, to defeat even the biggest of challenges we face. In my lifetime, we defeated SARS, H1N1 and Ebola, to name but a few. We will defeat this too.
Diversification, Diversification, Diversification!
In all the hysteria, we must not forget the first conversation! How much risk is the client able to stomach? The point of building a well-diversified portfolio, both geographically and by asset, is to reduce the exposure to market downturns like this. We can see from the graph that follows, a portfolio split evenly between fixed income and equity, and then diversified by global market cap has suffered a YTD performance loss of – 13%. But this is nowhere near the losses that equity markets around the world have seen. So, the next time you watch the news and believe that you have lost “over 20%!” because the FTSE did, remind yourself how we have built your investment portfolio.
In times like this, I find it particularly helpful to draw on the work of legendary scholar of international public health: Prof Hans Rosling. His book “Factfulness” is a must- read, particularly right now, but I want to draw out a few words that speak to me as I think about the current challenge that our world faces:
“Critical thinking is always difficult, but it’s almost impossible when we are scared. There’s no room for facts when our minds are occupied by fear.”
“Remember that the media and activists rely on drama to grab your attention. Remember that negative stories are more dramatic than neutral or positive ones. Remember how simple it is to construct a story of crisis from a temporary dip pulled out of its context of a long-term improvement. Remember that we live in a connected and transparent world where reporting about suffering is better than it has ever been before. When you hear about something terrible, calm yourself by asking, If there had been an equally large positive improvement, would I have heard about that? Even if there had been hundreds of larger improvements, would I have heard? Keep in mind that the positive changes may be more common, but they don’t find you. You need to find them.”
“Think about the world. War, violence, natural disasters, man-made disasters, corruption. Things are bad, and it feels like they are getting worse, right? The rich are getting richer and the poor are getting poorer; and the number of poor just keeps increasing; and we will soon run out of resources unless we do something drastic. At least that’s the picture that most Westerners see in the media and carry around in their heads. I call it theoverdramatic worldview. It’s stressful and misleading. In fact, the vast majority of the world’s population lives somewhere in the middle of the income scale. Perhaps they are not what we think of as middle class, but they are not living in extreme poverty. Their girls go to school, their children get vaccinated, they live in two-child families, and they want to go abroad on holiday, not as refugees. Step-by-step, year-by-year, the world is improving. Not on every single measure every single year, but as a rule. Though the world faces huge challenges, we have made tremendous progress. This is the fact-based worldview.”
“People often call me an optimist, because I show them the enormous progress they didn’t know about. That makes me angry. I’m not an optimist. That makes me sound naive. I’m a very serious “possibilist”. That’s something I made up. It means someone who neither hopes without reason, nor fears without reason, someone who constantly resists the overdramatic worldview. As a possibilist, I see all this progress, and it fills me with conviction and hope that further progress is possible. This is not optimistic. It is having a clear and reasonable idea about how things are. It is having a worldview that is constructive and useful.”
Stay sane. Stay safe. Wash Your Hands.