This article was written by Bastian Teichgreeber, Head of Asset Allocation at Prescient As we head into the festive season, COVID-related deaths have surpassed 1.5m worldwide this past year, and many countries, particularly in the West, are struggling to contain the spread of the virus. Nevertheless, stock markets put in their best performance in November despite the continued spiral in infections, with the economic impact not yet evident.
Investment managers have a view from the frontline during these crises and have the task of managing billions of rand of investor savings through perilous and unpredictable times. Bastian shares his learnings on what has, hands down, been one of the most difficult to navigate.
What do you think the most significant learning has been for investors this year?
As a South African who’s spent most of his life in Europe, I’m still very familiar with Mario Draghi’s famous statement in 2012, “Whatever it takes,” which marked the beginning of the end of the European Sovereign Debt Crisis. I was reminded about this statement during the Covid-19 pandemic. The willingness and ability of fiscal and monetary authorities to act swiftly have surpassed what we’ve observed during the last decade by a wide margin, and the impact of the measures implemented have been far-reaching. In fact, it has led to a decoupling of the financial markets from the real economy, which we’ve never seen before.
What has surprised you the most this year regarding the financial markets?
Most surprising has been the mismatch between economic activity and market performance, which was driven by the exceptionally easy financial conditions, along with the extent to which the US Federal Reserve reacted to what was initially deemed as a temporary crisis.
Are there any observations you can share about how policymakers have dealt with the crisis?
The three things that have stood out for me are:
- Government interventions in the daily lives and economic activities of their citizens, all aimed at focussing on one collective priority - to contain the spread of the coronavirus.
- Government spending and fiscal deficits are surging while private economic activity, not geared towards the collective effort, is plunging (at least temporarily).
- Once the collective effort is over, the return to a more normal pattern of economic activity will present some significant challenges.
What do you believe COVID-19 has taught investors about risk?
We have experienced a tail event that has affected the majority of risky asset classes. What has been interesting to witness is the correlation between the performance of these asset classes. We all know that during a period of crisis asset class returns and correlations move in sync, as asset class returns converge and correlations move closer to one. Having said this, the extent to which different markets all over the world moved in lockstep was unprecedented, with the dispersion in returns between asset classes reaching a new low. In SA, we saw equities, bonds, preference shares, listed property, the rand, and even income assets, fall at the same time during the March sell-off in response to the lockdowns.
What has COVID-19 taught investors about the relationship between financial markets and the underlying economy?
While the future will always be different to the past, and every crisis has a unique outcome, the decoupling of the real economy from financial markets during the Covid-19 crisis reached a level that we previously would have deemed impossible. Although the match between economic growth and financial market performance is not like for like, we would at a minimum have expected a positive correlation between the two variables. However, surprisingly in the second quarter of 2020, we saw the most significant drop in economic output in memory being matched by the second strongest equity market performance ever. This is evident in the chart below, which shows the performance of the economy versus the US stock market in the second quarter of this year.
What shortcomings and/or opportunities has COVID-19 exposed in the way investors generally approach asset allocation and diversification?
During this crisis, most surprising was how most managers were thrown by the rate of the change in the macroeconomic outlook. While the economic damage wrought was significant, the recovery was remarkably different from anything we had experienced before. We learnt that the activities that are being switched off in the current economic plunge could, and mostly will, be switched on again.
The majority of these activities will still be required once restrictions are lifted, step-by-step. The return to pre-COVID patterns of activity is far less a challenge than an authentic transition from an ordinary recession to a typical recovery.
Of course, the pandemic and the lockdowns will almost certainly trigger some lasting structural changes. These will include shifts towards online shopping and more flexible working models, including more stints in the home office. But these changes are unlikely to cause sufficiently severe disruption to initiate any material damage on a macroeconomic scale. Of course, these structural shifts in behaviour patterns will have a substantial impact on individual sectors.
What lessons, do you believe, South Africans have learnt during COVID-19?
No pandemic lasts forever. However, the COVID-19 shock will leave a significant surge in debt in its wake, which could spell serious trouble for governments once nominal and real interest rates begin to rise again. The outlook for inflation and thus for monetary policy will be a critical factor in determining the path of economic performance and financial markets in the coming years. BM/DM
Prescient Investment Management (Pty) Ltd is an authorised financial services provider (FSP 612).
The value of investments may go up as well as down and past performance is not necessarily a guide to future performance.