The Coronavirus correction
The market selloff
Equity markets saw a strong rally from the start of 2020 up until 20 February. Key to this was increased risk appetite following Government and Central Bank Stimulus flooding the financial markets with excess liquidity. We also saw the US-China trade deal and a pickup in economic indicators globally. It looked as though the global economy was turning the corner after a tough period dealing with the US-China trade war and the “will they, or won’t they?” Brexit saga.
The coronavirus pandemic broke that confidence. We saw one of the fastest bear markets in history with the Australian share market falling -36.5% and the US share market, -33.7% in AUD and USD terms respectively from 20 February to 23 March.
What held up well?
Low volatility shares are meant to fall less than the share market but also not necessarily do as well on the upside. Generally, this has held true even in this period with low volatility shares slightly outperforming on the downside. Companies in consumer staples, utilities or healthcare are all sectors which generally exhibit low volatility characteristics. Since their goods and services are often necessities e.g. groceries their actual businesses have held up well or even outperformed on surging demand e.g. the toilet paper shortage.
Other, more defensive assets did their role well in cushioning losses. Bonds, both Australian and international, held up well with limited capital loss while gold was the best performer over this period. Gold has been volatile since then with a decline over 11% between 18 May and 9 June while global equities were up over 4%.
Typically, property & infrastructure investments are held to provide growth with a hedge against inflation. Historically these assets have tended to hold up better in equity market selloffs. However, as we can see in the below chart that dynamic did not play out this time due to the nature of the crisis. The coronavirus pandemic was a situation almost perfectly suited to disrupting the business models of these companies. Retail property trusts or infrastructure companies are highly reliant on people moving through their stores or toll roads for example. The lockdown restrictions and the limited prospect of complete recovery in the near term has seen these assets be amongst the worst-affected in the sell off. Even in the recovery phase they have continued to lag broader market performance as shoppers and traffic has been slower to come back globally. Importantly though not all real estate assets are created equal. For example, Data Centre REITs have been major beneficiaries of this pandemic given lockdowns saw more data demanded with a rise of 8.8% for the March quarter as opposed to a fall of -51.3% for the Resorts subsector. Self-storage and infrastructure REITs (e.g. cell towers) were other winners with both losing less than -10% over the same period vs an index decline of -28.3%. This highlights the benefit of active managers in this sector.
Another notable “loser” in this period was being hedged to the Australian Dollar. This makes sense if you consider how our currency is seen by the rest of the world. We are closely tied to China and global economic growth through our commodity exports. In periods of economic weakness, the prospects of these exports fall leading investors to sell Australian assets and in so doing drive our currency lower. By being hedged you must weather the full impact of that selling. This is what led hedged international shares to fall over 10% during the peak of the sell off.
The nature of this recession is different to the past. In many ways it was tailor-made for online businesses to take market share and accelerate some changes already underway. That supported the strength of tech sector stocks such as Amazon boosting online sales even more. Emerging markets were another area of surprising strength, a reflection of China and other Asian countries doing better at handling the coronavirus pandemic than other regions of the world.
Fresh reminders – there’s defensive and then, there’s defensive
Some investments going into this period masqueraded as defensive options. That did not fully prove to be the case. Some specialise in targeting higher-quality corporate investments. However, at the peak of the selloff these funds also suffered - not by as much as share investments generally, but definitely worse than traditional bond funds.
At the same time, some defensive assets have been unfairly maligned. A global pandemic was not in most allocator’s base case scenarios. The unique circumstances that hurt property and infrastructure investments here are unlikely to repeat in other cases so, we would argue, they still warrant a place in client portfolios. They provide a degree of diversification from equities and provide some inflation hedging characteristics.