The coronavirus pandemic will probably last for a few years, but investors are still unusually optimistic, says Royal London Asset Management’s Trevor Greetham.
“I think we just have to assume this is a really long, drawn out crisis,” he said. “There’s a tendency to think these things take three months or six months to work through.”
He recalled how the Spanish flu took two or three years before it was over, and although modern science will speed things up this time around, he reckons it will still take a long time to get through.
Indeed, a widely available vaccine is not expected until the middle of next year, and it will be first administered to health workers and other particular groups before the wider population.
Discussing the UK as an example, Greetham highlighted the fact that the Office of National Statistics’ (ONS) immunity survey found only 6.2 per cent of randomly tested people in the UK over the last six months tested positive for antibodies.
He said: “If you cast your mind back to the beginning of the crisis when [UK chief medical officer] Chris Whitty and others were talking about herd immunity, they said you needed to get to 60 per cent immunity, and we’re currently at just over six per cent, a tenth of a way through.
“I think we just have to hunker down here and assume this is quite long. We’re going through the northern hemisphere winter with virus numbers picking up in Europe in the US without an effective vaccine available.”
As a result, he is quite cautious in terms of the economic outlook.
Despite the risk that Covid-19 still poses to the economy, Greetham is worried about the current level of investor sentiment around equities, which is slightly on the ‘optimistic side’ according to his indicators.
Investor sentiment indicator
Source: RLAM
The indicator measures investor sentiment through a combination of monthly S&P 500 returns, the CBOE Volatility index, private investor sentiment, and company director buying activity.
He said: “The coronavirus crisis got us to worse than minus 4, which is a new record in terms of the degree of panic, outstripping the Lehman crisis, or the euro crisis.
“Now our indicator is plus 1.2, so if anything, we’re in the kind of greedy area.”
He observed that in recent weeks, there has been quite a high degree of selling by US company directors of the shares and their own companies.
“That worries us because when directors are buying aggressively as they were in March, it’s a good buy signal, but at the moment, they’re selling,” he said.
The most bullish signal is a drop in the market, VIX spiking, private investors being bearish and company directors buying.
“That’s what we saw in March when the signal was down to minus four,” said the multi-asset manager.
“Now volatility is quite low, markets have been going sideways, private investors aren’t too scared, and company directors are selling.
“It’s not the things you’d really want to see. We need to see panic in order to want to buy and we’re nowhere near that at the moment.”
If he starts to see positive trends emerging on the virus numbers or the macro data or new stimulus causes the market to rise again, he’ll also go from a more neutral position to buying.
However, there is one asset class he is largely overweight in: global high yield bonds.
Greetham added: “We think that’s quite a good place to sort of hang out waiting for the crisis to finish, because you’re picking up some spread there and central banks are treating credit as a special kind of asset class.”
Graph of high yield
Source: RLAM
The graph above shows the high yield spread over government bonds in purple, and an indicator from the quarterly senior loan officer survey from the US Federal Reserve in red.
“This graph actually is quite worrying on the face of it, because it’s asking the question, whether banks are tightening their credit terms,” he explained.
“Banks are tightening their credit terms, because they’re obviously worried about the credit worthiness of the companies they’re lending to, but the banks don’t seem to matter at the moment because the Fed is effectively directly lending to the corporate sector in America through the bond markets.
“So, in 2008, a lot of lending going on in the world was through banks, and in 2008, we had a credit crisis and the banks were too big to fail and they got bailed out. In 2020, it is the credit markets that were too big to fail.
“They’ve taken the place of the banks, they got really bloated due to the hunt for yield that was going on because interest rates were zero and there was this mountain of money in the US corporate debt market.”
He said the pandemic could easily have turned a health crisis into a financial crisis if it wasn’t for the very early decision by the Fed to earmark a $1trn to buy investment grade credit, and even if necessary, buy high yield bond exchange traded funds.
Granted, he admitted that if there are serious dips in the economy, there will be some movements in the market, but he reckons global high yield corporate bonds will get central bank support very quickly as opposed to other asset classes because of how crucial it is to keep credit flowing in the economy.
Performance of fund since launch
Source: FE Analytics
Greetham’s £181m Royal London Multi-Asset Strategies fund has lost 2.9 per cent since launch in November 2018, compared with gains of 8.95 per cent from its Bank Of England Sterling Overnight Index Average + 4 per cent benchmark.