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Davy update to private clients - 11th March 2020

11th March, 2020

When we initially sit down with clients to plan their asset allocation, the appropriate level of risk is always key. But it can often feel like an abstract discussion. Now as we sit in the middle of a global health scare and extreme market volatility, risk feels all around us. Though we take comfort from our blend of growth and defensive assets, remembering from previous panics, it never felt comfortable to be invested through times like this. Nobody can know how long this current crisis period will last. However, we know from experience that keeping a patient and steady hand is eventually rewarded.

The Coronavirus (Covid-19)

Initially a China problem, since the middle of February the infection rate has risen dramatically in Europe and is also rising in the United States. Thousands are infected in Italy, France and Spain, and the Italian government has effectively locked down the country to contain the virus. Experts anticipate many more cases and more deaths. However in China and South Korea, the rate of new infections has fallen, as their social distancing policies have proven effective.

The oil shock

Oil prices fell from $62 a barrel in January to below $50 on fears of weaker energy demand due to the impact of the virus. In recent years, Russia and the OPEC producers would have agreed on production cuts to support prices. This time however, they failed to agree, and Saudi Arabia is instead now increasing production. This extra supply is causing prices to drop even further to the low $30s. This will hurt energy producers around the world, including US shale oil, and help energy importers like Europe and China.

The economic impact

Apart from a record fall in the Chinese Purchasing Manager Index (PMI)*, we have yet to see the impact of the corona virus in slow-moving economic data. Forecasters such as JPMorgan are now predicting a first quarter contraction and a subsequent recovery. The forecast decline is particularly sharp for China, less so for Europe, with potential stagnation for the US. But importantly this is not currently a full-blown recession. Our main concern is that a broader spread of the virus across the US could lead to job losses and a collapse in consumer spending, which would lead to a recession. We are comforted by the strength of the US consumer, with unemployment at only 3.5%, the high household savings rate of 7.9%, and now lower oil prices. Governments and central banks are aware of these broader risks and are stepping in to support the economy with extremely low interest rates and fiscal stimulus too.

The market impact

The last week of February, which saw markets down 11%, was the worst since the financial crisis. Monday the 9th of March, with a drop of 7%, was the worst day since the financial crisis. From the peak in February to Monday’s close, the US market was down by 19%, and Europe by 23%. Bear markets, i.e. down by 20%, are very unusual outside recessions. While we are not brave enough to call a bottom in the market, this feels like an over-reaction.

Our investment view

Given that we believe that the virus impact will be temporary, and that markets are already priced for quite a negative scenario, our recommendation is not to sell equities now. To be clear, we are not saying that the virus nor the market crisis will not get worse. Just that the balance of risk and reward has moved more in favour of investors due to the recent sell-off. In fact, for our discretionary model portfolios we have taken advantage of this sell-off to increase our equity weight temporarily. Given that the data is so noisy and that we are likely to see further bad news in infection rates in Europe and the US, we make our portfolio changes in stages. For advisory clients, if portfolio adjustments are being recommended, your adviser will contact you with relevant proposed changes in the context of your individual circumstances.

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