Market report March 2020

The virus-related health crisis is an unprecedented shock in modern times for modern society and the global economy. Investors can regain their balance by following a series of strategic guidelines in times of extreme uncertainty. Creative thinking, sober assessment of short-term challenges and focus on long-term business foundations and valuations are the key to identifying companies that are ready to survive a pandemic and grow in a new reality after the crisis.

As with the global financial crisis, governments are likely to adopt policies that would otherwise seem unimaginable. Investors should be humble about what they know and what they don’t. Making decisions based on what decision makers can do is not investing, it’s gambling. Trying to suppress noise emitted by popular financial and social media and focusing on foundations that can be understood, such as microeconomics, business models and cash flow is probably the right way.

Investors should analyze all probable scenarios, even the improbable ones. The 2008 global financial crisis negated many conventional assumptions. In today’s environment, the unthinkable can become a reality. Past precedents must also be avoided to determine what types of capital allocation will provide a stable portfolio value today.
Societies will one day come out of this extreme uncertainty, and life will settle in a new norm. This will probably take some time and the global economy will experience a deep contraction in the meantime. Stress testing on a company’s ability to survive in various scenarios is crucial when choosing an action. Balance sheet strength and cash flow continuity in the event of a severe downturn are two key indicators that can help identify companies that can survive. In the meantime, some companies may report large losses in the income statement when the economy is shrinking, but strong balance sheets will help them survive and bring benefits when the situation normalizes.
This is not easy when economies are facing a growing human tragedy and are facing a huge economic crisis. Some companies will not survive. Other business models will never be the same and may change permanently.

Pursuant to section 13(3), the Fed may implement fiscal policy

As part of a holistic effort to support markets, the Federal Open Market Committee (FOMC) lowered the reference rate to zero, resumed quantitative easing (QE) and pledged to pump several trillion dollars into the repo market if needed. With market rates record low on the entire yield curve and no prospects of interest rate increases on the horizon, we believe that QE will be rather ineffective in stimulating growth. The Fed still has a role to play due to its crisis management capability. This role results from the part of the Federal Reserve Act that has not really been used since the global financial crisis (GFC). This is section 13(3), which gives central bankers the power to create a mechanism for transferring money to disadvantaged areas of the economy. The FED used this right to save Bear Stearns, buy AIG and create credit lines for Primary Dealers (PDCF-Primary Dealer Credit Facility), term loan (granted for one month for Primary Dealers) against the security components of the SOMA portfolio (TSLF -Term Securities Loan Facility), term loan against asset-backed securities (TALF-Term Assetbacked Securities Loan Facility) and commercial paper financing instrument (CPFF-Commercial Paper Funding Facility).

These movements have reduced the risk in the financial sector and in our view, have helped prevent the collapse of the financial system during the difficult period of the global financial crisis (GFC). In mid-March, the Fed re-launched CPFF and PDCF, making it clear that the central bank is willing to exercise the powers of section 13(3) of the Act. Today’s problems are not focused so far on banks, but on industries such as travel, entertainment and retail. The FED has generally interpreted the scope of regulation 13(3) as limited to financial enterprises. The act was amended after the GFC to clarify that company-specific bail-out funding would not be acceptable, which would explain the emphasis on ‘extensive’ programs. The FED could justify that setting up a broad fund to support systemically important sectors and/or households is legal and acceptable within the scope of the central bank’s mandate. Even if the Fed does not want to directly support a given sector, it could create a broader program for banks to channel money to sectors under pressure. The Fed would direct the money towards the economy in a manner usually reserved for fiscal authorities, which would have to be approved by the Treasury Department. This would not increase the budget deficit, the money would go to the balance sheet position in the FED financial statements. The operation would not require Congressional consent. The FED would issue loans instead of buying equity, which would address the fear of nationalization. During a recent press conference, Jerome Powell said in the context of regulation 13(3) of the Act: “… is part of our handbook in such situations.” He also said that the FED is ready to use its powers to support borrowing and lending in the economy to support the availability of loans to households and businesses. Crisis management is another political priority and regulations 13(3) provide the Fed with room for action. If the economic situation does not improve in the near future and the decision makers fail, we expect the FED to go beyond the GFC manual. Those interested in the details of the program launched by the FED (9 April) are referred to our article on the subject (article link).

A few words about how to deal with the changing market situation

It is perfectly normal that in volatile markets, investors question their investment approach and focus on the potential for short-term losses, often at the expense of a long-term investment strategy. In unstable times, there is the temptation to withdraw your money from the market or stop investing while waiting for the “perfect” time to invest. We do not question this approach. Everyone should decide on the fate of their own money. Trying to determine the right time to exit or enter financial markets is difficult. Making a mistake can be very expensive, which in turn can affect long-term profits. Often, the largest movements in the markets, both up and down, occur in concentrated periods of stress and euphoria, which makes it extremely difficult to predict when they will occur.

The chart shows a number of events, including the September 11 2001 attacks, the 2008 global financial crisis, the 2011 Greek debt crisis and the recent virus outbreak. Events, which many perceived as negative at the time, were absorbed by the market, while others caused significant periods of turmoil. This is the unpredictable nature of short-term market movements. It is important to consider your investment strategy in the long term and make investment decisions in this context.

– Morning Star Global Equities Index

Source: MorningStar, RCieSolution Research

Completely removing volatility is difficult. Investing in multiple asset classes provides diversification that can help you navigate in periods of volatility. On behalf of our clients, we invest not only in the company’s shares, but also in other investments across the entire risk spectrum. Proper investment timing confirms the manager’s competences.

We decided to publish every quarter results of our investment portfolio managed by Rafal Ciepielski – CEO RCieSolution. The portfolio is constructed using all available financial instruments, short sale, derivatives, precious metals, and commodities. The main criterion used in the construction of the portfolio is the liquidity criterion. The publication of the portfolio results starts from 17.02.2020, the day on which the observations about the market situation and its further perspectives were published in the Linkedin portal:

https://www.linkedin.com/pulse/i-like-market-wind-any-clouds-horizon-rafa
https://www.linkedin.com/pulse/seems-like-us-stocks-markets-everybody-rafa

European Monetary Policy

The European Central Bank announced a further monetary policy adjustment, introducing a bond purchase program worth at least EUR 750 billion this year. Importantly, this allows for a short-term departure from the capital key mechanism that maintains ECB purchases approximately in proportion to the size of the economy of each Member State and includes Greek bonds, although they are below investment level.

Media reports (14-15.03) suggested that Germany would increase discretionary spending by about 3% of GDP, which would probably have its consequences. Debt economies like Italy can be more challenging. In response, the discussion begins whether to alleviate the financial conditions imposed on such EU countries as a precondition for access to financing instruments such as the European Stability Mechanism.

Petroleum

In connection with falling oil prices, the Energy Information Administration announced plans to increase strategic oil reserves by 30 million barrels of oil. The offer is available to small and medium-sized US companies that employ less than 5000 employees. President D.T also said he would “take part” in the production dispute between Russia and Saudi Arabia “at the right time.” During the OPEC meeting on April 9, Saudi Arabia and Russia, under a joint agreement with OPEC +, undertook to reduce production by 23% of the current production level of each, limiting production to 8.5 million barrels/ day in May and June. The associated countries are counting on increased demand and reconstruction of the global economy in Q4 2020 and on the joining of other G20 countries (not associated in OPEC) to the process of reducing oil production. The global oil balance indicates the need for a greater reduction in production (a minimum of another 10-15 million barrels / day), which would be mainly at the expense of production in Saudi Arabia and it is unlikely that a compromise could be reached. The global demand shock is too large and requires, in our opinion, gradual adaptation changes in the production process. In addition to import duties and political pressure, the US administration will probably also start the process of reducing production by about 2 million barrels/day. The key issue is how much the timing and size of changes in the production process will affect the global oil balance in an effective manner. Whether the agreement reached will be implemented remains a separate, open question.

US policy

On Monday 16 March, the US Federal Reserve announced the launch of an unlimited bond purchase program to keep borrowing costs low. Two instruments to support the availability of loans to large employers, a third instrument to support loans to households and small enterprises, and provisions to support municipalities were also established. Details on individual programs are presented in a separate article (link to the article). Last week, the FED also launched USD liquidity swap lines with Australia, Brazil, South Korea, Mexico, Singapore, Sweden, Denmark, Norway and New Zealand to support global liquidity.

At government level, the Senate has donated funds to provide free testing and 10-day paid sick leave for people with Covid-19 to manage the infection rate. However, on March 27 Congress passed the much-needed fiscal stimulus package, which can be as high as USD 2 trillion (The Cares Act). The package may include direct payments to Americans, $ 300 billion in tax deferrals, and the same amount as continuous loans for small businesses. While liquidity measures are important, it is highly likely that the government will have to step in to minimize the economic impact of the measures and actions needed to slow down the spread of Covid-19.

Global stock markets

Global stock markets, respectively, in terms of 1 week (1 WEEK), 1 month (MTD), calendar year (YTD) and the last 12 months (1 YEAR), are shown in the table below:

The table includes rates of return in terms of pound sterling (GBP), local currency (Loc.) and relative (Rel.) As at 20/03/2020

Source: RCieSolution Research

The views expressed in this document do not constitute research, are not investment or commercial advice and do not necessarily reflect the views of all management teams. They change over time.