Covid Market Implications
“Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No.1”
– Warren Buffett
Successful investing is about finding inefficiencies and errors in markets and waiting for them.
During the 2020 March-May (CoVid19 crisis), I have been writing different articles pointing out how to manage the situation on positioning investments conservatively.
It’s now time to review these ideas and opinions and think about the next six months to come.
So, let’s analyse what I was writing five months ago and see where I was right and where wrong and why.
“Global inflation will not grow fast so that I can expect low rates for a specified period. Later, however, inflation may increase. For this reason, I prefer a short duration to a long one, and I think that inflation-linked bonds can also be attractive in the medium term (and certainly as an element of diversification).” USD could depreciate
This prediction of COVID market implications has been correct.
Both Germany and the USA (benchmark markets) have been experiencing a first time deflation.
The significant intervention of Central Banks will probably lead to a mid-term inflationary pressure with an increase of the long-term interest rates allowing for a reverse yield curve.
Inflation-linked bonds may, therefore, be an exciting alternative to traditional money market instruments. Timing will be crucial when the investor enters these vehicles. I believe beginning 2021 could be the right moment to assess inflationary pressures and decide whether to enter or not.
“USD could depreciate significantly against both CHF and EUR and emerging currencies in particular RUB, MNX, and INR could benefit from a faster economic recovery in the medium term.”
This prediction has been correct for the USD. The USD has lost in value over the last four months, against CHF and EUR.
This prediction has not been correct for RUB, INR, and MXN. All these EMMA currencies have not yet recovered from their massive losses, and the impact of CoVid19 is still difficult to assess.
However, over the next six months, I still believe that all three currencies, because of different reasons, will appreciate against the EUR.
However, differently than before, the interest rate differential is not a cushion anymore. Therefore, one investor may wait before taking exposure towards these EMMA currencies since interest rates may be driven up by inflation in the medium term. So, if investing, stay on the short side of the yield curve.
“CHF could strengthen significantly against both EUR and USD despite the SNB’s efforts to maintain a stable exchange rate at least against EUR.”
This prediction has been correct only against USD; against EUR, the CHF has lost value in the last months.
Over the next months, as soon as the dangerous game played by ECB and FED will become more evident, both currencies could continue to lose value against CHF.
Investors having CHF as their reference currency may, therefore, consider at least hedging their positions.
In commercial trade this may be even more important.
A last consideration for the Swiss economy is how much will the SNB be able to stretch its balance sheet to support the CHF?
“Credit spreads from BBBs to junk bonds should first stabilize as a result of Quantitative Easing and then rise after that for at least 12 months. Attractive then an exposure on ultra-short-term funds with an average BBB rating maybe even with a little leverage.”
This COVID market implications prediction has been correct.
I have personally increased my exposure to the HY bond sector end of March 2020 (after the sharp march correction) and this investment idea has been an essential tool to improve (defend) performance in the IIQ 2020.
I, however, believe that this correction in yields is now over and that a second increase/spike in risk premiums will follow.
An incredible divergence is taking place between corporate bond spreads and the number of companies filing for bankruptcy. I therefore firmly believe that it’s only a matter of time until this will result in higher risk premiums and bankruptcies of fallen angels and HY bonds.
Ultra-short-term positions may only partially cover the risk of increasing spreads because, as we saw in March, an illiquidity spread may impact these ultra-short term bonds that, therefore, may have to be kept until expiration (or default).
“Stocks globally are not yet suffering from the supply and demand crisis that social distancing will generate (not to mention the change in the propensity to consume that there will be with an unnecessary shift in spending). A gradual entry must be compensated for adequate opportunities. In my opinion, this will happen only when from current levels, the market will have discounted an additional 20 to 30%. An easy entry can be made with ETF but also on quality securities that will move only as a result of the beta. The most attractive sectors are those of infrastructure that will benefit from direct investment by governments to generate jobs and reduce unemployment (a New Deal 2.0 at Rooswelt globally). I also like cash-rich companies and companies able to create so much cash that they can now make price-based acquisitions and grow exogenously.”
This prediction has been wrong (partially) in particular:
- I underestimated the effects on equity on the intervention of FED and ECB
- I underestimated the FAANG effect.
- I underestimated the impact of Robinhood investors
- I underestimated the effect the three above facts may have on beta
- FAANG (+ Microsoft) make up 23% of the whole S&P index.
- equity market recovery has not been homogenous in terms of single shares neither in terms of performance of global equity markets
- Volatility in equity markets has decreased significantly also due to FED / ECB interventions
- Markets are in greed mode
In my opinion, the risk-reward ratio was low into investing in equity during the crisis, and I now believe (for US markets) it’s even lower!
Again, let me quote Warren Buffet: “Price is what you pay. Value is what you get.”
In other words, don’t focus on short-term swings in Price, focus on the underlying value of your investment.
“Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”
We are currently navigating in a very challenging and complex environment, and seeking value is a process that also requires patience and a medium-term view.
Companies are valued by their capacity to generate profits. We are currently in an environment in which profits are getting lower (dividend pay-out ratios as well), consumer spending lowering, and all significant macroeconomic variables are worse than one year ago (in some countries one decade ago). Therefore, why should equity markets be up compared to one year ago?
Let’s be patient, let’s select (go for alpha) and make’ 0s look for value avoiding the yawns.
“Still, for the equity, I believe that some geographical areas of the world can benefit more from the future economic recovery and among these, in particular, ASIA/PACIFIC and ASIA ex-Japan.”
This COVID market implications prediction has been correct.
If you are not trying to time the market, these two markets are still the cheapest to be bought.
However, if you are keen to time the market and you believe a correction may be coming in the equity market as I think, then you should also sell these winning strikes and try to repurchase them cheaper once the revision has been rolled out.
“As far as commodities are concerned, I prefer Silver to gold because COVID MARKET IMPLICATIONS immediately after the crises, Silver generally outperformed gold. I find an indirect leveraged entry using call options without investing too much and possibly also benefiting from increased volatility.”
This prediction has been correct and both Gold and Silver have outperformed equity and also FAANG since march 2020 and this has been an essential tool to improve performance in the IIQ 2020.
I played this prediction with call options on Silver at the money speculating not only on price increase but also on volatility increase. It was a right and lucky choice.
I believe that there is still potential for a price increase in Silver and Gold. I think Silver still has better chances of growth due to its price reaction in turbulent times and the even above average gold/silver ratio that may bring Gold speculators to switch into Silver.
“Finally, it could also be interesting for those who do not have a minimum of diversification in cryptocurrencies that can be a good hedge when the national currencies will devalue among them as always the BTC but also the BCH.”
This prediction has been correct and BTC has outperformed any asset class delivering triple digit growth! Integrating this new asset into portfolios increased diversification and let to great performances.
I played this prediction buying BTC but also during the last month switching into ETH to benefit from the DeFi speculation taking place.
It’s however a complex asset class for sophisticated investors capable of tolerating also high volatility and in some cases heavy losses.
So in general terms I have done a good analysis of financial markets in March/April with the important complaint of not having seen the FAANG appreciation.
But I was not alone; both Buffet and Dalio, which are amongst the best and most reputable investors world-wide, committed the same error.
Errare humanum est, (sed) perseverare diabolicum
Let’s keep up in the next months a lot of opportunities will arrive and I am more and more convinced that these challenging times will require the search for short term asymmetric investment ideas combined with a longer term defensive strategy searching for value and not speculation.
This is not a recommendation! Figures refer to the past and past performance is not a reliable indicator of future results. Seek independent financial advice! This text is distributed for information and educational purposes only. No consideration is given to the specific investment needs, objectives or tolerances of any of the recipients. In addition, the actual investment positions of the writer may, and often will, vary from his or her conclusions discussed here based on a number of factors, such as client investment restrictions, portfolio rebalancing and transaction costs, among others. Recipients should consult their advisors, including tax advisors, before making any investment decision. This report does not constitute an offer to sell or a solicitation of an offer to buy the securities or other instruments mentioned.