Mawer Market Update—March 20, 2020
Over the last week, the world has seen a continued increase in COVID-19 cases and, consequently, a greater effort to contain the virus. This trend represents Benoit Mandelbrot’s concept of fractals, a mathematical pattern where each part resembles the greater whole (see: The Misbehavior of Markets: A Fractal View of Financial Turbulence). We can see this pattern reflected in how the earlier virus’ exponential spread, e.g., Italy, is now being played out in other countries. Applying a fractal framework suggests we should expect more cases in western countries and a greater effort towards containment. It is possible the United States will have close to 500,000 cases by the end of March. It is also notable that with enough containment and testing, the curve eventually flattens—which has been the case in China.
While containment initiatives are of utmost importance in defeating the spread of COVID-19, they have also resulted in significant economic deterioration, including the closure of businesses and the furlough or unemployment of people around the world. Over the last week, global financial markets have declined, attempting to discount the economic impact. With such a wide range of probabilities on how events could unfold, the result has been substantial volatility in asset prices.
Authorities have acted quickly to support the economy by making it rain money. Aside from traditional monetary policy, such as reduction in interest rates and newer tools such as asset repurchases (quantitative easing), there have been indications of a greater fiscal response. This includes direct fiscal programs intended to stimulate the economy, the consideration of indirect fiscal programs such as the deferral/abatement of taxes or increase in medical benefits, and proposals of directly writing people cheques aka “helicopter money.” Historically, “don’t fight the Fed” has been sage advice.
Over the last week, bond markets have become correlated with equity markets, as bond yields have increased slightly. It is possible bond markets are anticipating greater inflation if it rains money for long enough. It is also conceivable that part of the pressure on fixed income markets is resulting from rebalancing, as institutional investors seek to sell bonds and redeploy capital into equities that are now more reasonably valued for the long-term. Overall, credit markets remain in a more fragile state, and it is reasonable to expect defaults, which is the case in every recession and bear market.
So, what are we doing about it? At Mawer, our team has emphasized increased communication both internally and externally. Internally, we’ve increased our use of technology to effectively share information and have also increased the frequency of meetings across teams to facilitate remote work. Externally, our research team has been in ongoing contact with companies and industry participants to better understand the economic consequences of the past few weeks, as well as the potential implications for the future.
Despite the increased volatility of the past week, our base thinking hasn’t shifted. We’ve stuck to our long-term investment philosophy, emphasizing companies that have strong business models. In general, these companies tend to generate more recurring revenue, are less discretionary in nature, and are typically highly cash generative. And in managing through this turbulent time, our philosophy continues to be:
- Stay balanced and diversified, in regard to both our portfolios and decisions.
- Attempt to be in two spots at the same time—make decisions so that portfolios are relatively well-positioned, whether we land in a positive or negative scenario.
- Continue to look at the world with a long-term view, shifting away from the risks and towards the opportunities.
And finally, one of our highest priorities, to quote an often-used mantra, is to keep calm and carry on. The world is rarely as dark—or as rosy—as our emotions may suggest.
—Mawer Global Research