New article from Tatton Investment Management: This week's market correction requires perspective

28 February 2020

We published an assessment of the market impact of the COVID-19 flu pandemic, and the medium-term changes to our 2020 market outlook on Wednesday, but following today's media reports and the continued falls in stock markets since then, we felt a further update may be helpful:
 
After three weeks of stock market resilience, the broader investment community has finally taken note of the fact that the COVID-19 induced economic activity slowdown is not confined to ‘faraway’ China, but has significant ramifications for the global economy as a whole. 
 
As a consequence, investors are repricing corporate earnings prospects - albeit under a very short term and worst-case perspective.
 
Following on from overnight declines in the US and the Far East, we have to expect another big ‘red day’ for UK and European markets - before a bounce becomes likely, as institutional investors begin to see value opportunities returning and start their inevitable ‘dip buying’ and ‘bottom fishing’.
 
It is true – as the media is keen to report this morning - that the stock market falls experienced in the past week is one of the biggest single-week declines we have experienced since the financial crisis of 2008/2009. However, this needs to be put into perspective after the significant stock market climb we have experienced since the beginning of last year. Yes, the US S&P500 suffered its largest ever one day drop in points terms on Thursday, but this 4+% drop is steeper because of the altitude.

The index is already at record-breaking levels, which should be remembered when we compare it against historic falls that originated from a smaller starting base.

Our Tatton portfolios are obviously not immune against these downward market moves. But to put the declines into context, even with the impact of the ongoing declines, our portfolios have only given back some of the gains made since the summer of last year.
 
Our preference for prudent and sensible diversification means that our portfolios are not exposed to any single region or particular sector. Indeed, we have already observed their performance holding up somewhat better than some other investment strategies, particularly those that stormed ahead in the heady markets of last year on higher regional risk exposures.
 
Just as during the last stock market correction in the final quarter of 2018, it is possible that we will have to issue -10% decline warnings to investors in some of our highest equity exposure portfolios. But for the time being, this remains confined to the Global Equity and Aggressive strategies.
 
We entered this market correction with a slight equity overweight of 3%, which is allocated to Far East Asian equity markets. We took this position at the very beginning of February, knowing that the Coronavirus disruptions would lead to a global activity slowdown in the first and possibly second quarters of 2020, and that this would trigger a very broad-based stimulus effort on the part of central banks and governments around the world - starting in China. This is already panning out and indeed those eastern emerging market equities have held up better than some others, while China is already showing clear signs of the peak of the epidemic passing and China’s economy - and its workforce - getting back to work.
 
There is a widely-shared expectation among market strategists and economists that short-term shocks to the system like virus pandemics do not lead to lasting economic declines. Instead, they tend to cause short, sharp slowdowns that are usually outweighed by V-shaped recoveries soon thereafter. With the global economy having already embarked on an upswing from the 2018/2019 manufacturing slowdown, we see it as very likely that the COVID-19 countering stimulus actions will magnify this rebound, once the current hiatus from economic activity is overcome.
 
As indicated at the beginning, you will have received an update note from us on Wednesday, which you can access through the document link below. I have also laid out in the last three editions of the Tatton Weekly how this virus scare compares to previous global flu pandemics, and why it is therefore prudent to take the longer term perspective, rather than place too much fear on the shorter term.
 
Since we founded Tatton Investment Management almost eight years ago, we have successfully steered our investment portfolios through many bouts of market volatility and several stock market corrections. This time around, the external shock of the Coronavirus scare has affected markets at a time when valuations had become extended in anticipation of the aforementioned manufacturing cycle recovery. Recovery remains on the horizon and, compared to previous corrections, the direction of the accompanying macro-economic development is more promising - even if the positive earnings impact will now be delayed to the second half of the year.
 
I hope this puts some of the disturbing news reports into perspective and provides you with enough context to answer questions which may have arisen since our last update on Wednesday.
 

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