The world's stock markets are currently experiencing one of the quickest corrections in modern history and the steepest since the financial crisis. This time is different to 2008 when there was high systemic risk to the global financial system, liquidity vanished, bankruptcies spiked and recession followed. Governments around the world responded by using – or inventing – tools to stimulate frozen markets which eventually returned to normal.
Today's situation is more comparable to the dot.com bubble, which also followed a long bull market culminating in expensive valuations, and burst following the 9/11 tragedy that sparked widespread fear. As now, the US president was seeking re-election which depended on a strong economy.
This time we are facing an invisible enemy. People are gripped with fear at the prospect of losing income, wealth or worse as their lives and those of elderly relatives are threatened.
The world has become surreal as we have awakened to the reality that we must fight this together with all means at hand. Our shared goal must be to limit the first wave of the virus assault as quickly as possible, secure food, education and shelter and help businesses secure jobs for the future. Extensive global monetary and fiscal policies have been launched on a previously unimaginable scale.
Experience and insight
The fund managers in SKAGEN are all experienced, having managed portfolios through previous corrections such as those during the financial and Eurozone crises or the Arabic spring. They are using these experiences – and the insights gained – to navigate the current fear and uncertainty in the best way possible for clients.
Volatility does not mean the market is riskier. In fact, the opposite may be true. As I have remarked over the past year, we have found it challenging to invest because of very high equity prices. The market is now very different. Trying to time it, however, is not a profession that we pursue. While these levels may look very attractive in retrospect, it is far from certain that we have hit bottom and we could see further steps down before they recover.
However, today's market may well prove to be a very good entry point if you have a long-term horizon – a view shared by some institutional investors we have seen use the dip to increase their equity exposure. We know that loss of capital will be temporary, but we also know that some companies and industries will suffer long-term damage. Here the advantages of active management within broad mandates are clear.
The approach of our portfolio managers combines the defensive with the offensive. They will continue to adjust their portfolios based on detailed analysis of company and market conditions; some businesses will become more attractive, others less so. At the same time, they will identify those businesses best placed to flourish when more normal conditions return, which they will.
In order to fulfill our fiduciary duty of generating the best possible returns for our unitholders, we need a healthy team. We have therefore divided the teams where most now work from home with a well-functioning IT setup. We keep in close contact with daily video calls and extensive use of collaborative tools. In addition, SKAGEN HR are actively working with our employees on how to overcome the daily challenges in these extraordinary circumstances.
So, how are we coping as fund managers in SKAGEN? Volatility is unprecedented – the VIX Index this week reached a record high – with the knee-jerk marking down of stocks due to single issue fears (i.e. exposure to tourism or the oil price) or top-down concerns (i.e. exposure to the hardest hit coronavirus areas like Italy).
As always, our portfolio managers, both equity and fixed income, remain disciplined, analytical and systematic. The difference at present is the pace of daily change with our investment approach characterised by three distinct but overlapping processes:
1.Securing our portfolios
Here we focus on minimising the effects of the sell-off and scrutinising the stocks that are most exposed, in terms of both income and balance sheet. The current circumstances will definitely change the outlook for individual companies; we trim or even exit stocks when we have less conviction over earnings estimates and debt burdens. Current sensitivities in the SKAGEN portfolios are within the energy sector, tourism, hotels, retail (particularly shopping malls) and cyclical companies with high leverage.
2. Manage and prepare
While securing the portfolios and managing through the crisis, we will continue to make minor adjustments depending on the outlook for economic growth in response to the prospects for controlling the first wave of the pandemic.
During this period, we also use our experience and knowledge to identify opportunities. We may revisit some prior holdings that we know well or companies we wanted to buy but were previously too expensive as well as identify new candidates that will perform well as we start to see light at the end of the tunnel.
We do not know how long the crisis will last and how deep the recession will be. Again, we need to stay systematic, analytical, disciplined and patient.
3. End in sight
When we believe the time is right, we will start to more aggressively accumulate stocks that we believe will do well when the economy normalises. We expect this to occur gradually when stock markets become less volatile as investors' confidence returns and value appreciates.
Contrarian buy signals
However dire the current outlook, we are confident we will beat the coronavirus and the market will return to normality. To help put things in perspective, technical indicators from Bank of America Merrill Lynch show we are entering a level of extreme bearishness that traditionally signals 'buy' territory, with the caveat that it contains limited historic pandemic data.
The global economy is without doubt entering a recession. Historically they have been triggered by large imbalances in the economy, such as excessive investment in housing (2008), IT (2001) or commercial real estate (1990). Their duration normally depends on how long it takes to correct the imbalance. The current slowdown is not driven by the build-up of an economic imbalance, but rather an exogenous shock, which suggests it will be short and deep. According to Deutsche Bank, the recession following the pandemic flu in 1918 lasted only seven months.
Finally, I would like to take the opportunity to reiterate that we are protecting our people so that they, in turn, can safeguard your investments with SKAGEN. We have a stringent and disciplined approach on how to handle the crisis and protect our clients' assets, and we will work tirelessly to ensure healthy returns when the world returns to normality.