Market behaviour, lessons from previous crises and what the future holds – a Q&A with fund managers

The first half of 2020 saw some of the most volatile movements in stock market history as the world battled with the coronavirus pandemic.

Between February and June, when most countries went into some form of economic lockdown, a record-breaking stock market bull run ended. We saw the most acute market crash in history, followed by a strong rally as governments and central banks stepped in to support the economy.

It is no wonder investors are struggling to make sense of it all. The outlook remains uncertain. Yet many investors appear to be optimistic about the lingering impact of the pandemic and future stock market returns.

For instance, a majority of investors reckon the economic effects of coronavirus will pass within two years, according to the latest Schroders Global Investor Study (GIS).

That optimism is not in line with many countries’ own official forecasts. In the UK, for example, the Office of Budget Responsibility, which now predicts decades-long consequences in terms of national debt, has questioned the extent to which “the resulting economic and fiscal damage [could] turn out to be permanent”.

Despite this, on average, investors expect stocks globally to return 10.9% per year over the next five years, according to GIS.

Investors’ comparatively optimistic response could be due to their experience in the past decade of healthy stock market returns – even while the world economy faced significant challenges.

With so much uncertainty and potential confusion we spoke to Johanna Kyrklund, Chief Investment Officer, and Robin Parbrook, an Asian Equites Fund Manager to get some clarity.

We wanted to get their views on the recent market behaviour, what lessons we can learn from previous crises and what to expect in the future.

Has the market recovery been justified?

Johanna Kyrklund: “Yes, because of the response from the authorities. In particular, there's nothing more powerful than a falling discount rate (interest rates), which is what we've seen across markets.

“If you look under the surface, the assets which have been performing are the ones that are directly benefiting from that falling discount rate.

“But I think that, as investors, we are suffering from an attention deficit.

“We are learning to cope with Covid-19, but I don’t think people are sufficiently focused on the possibility that it could go on for longer than we expect.”

Could that have a knock-on effect for markets?

Johanna Kyrklund: “Yes. As we enter the autumn, the big question is what is the probability of a second wave this winter?

“As things stand at the moment, you'd have to put at least a 20% probability on that scenario, just based on the scientific advice.

“If we get a vaccine sooner than expected, that would alter that probability very significantly. But that sort of oscillation in probability could cause some volatility as we head into the autumn.”

If we get a second wave, how likely is another national lockdown?

Johanna Kyrklund: “Full national lockdown is a nuclear option. What we've learned in the last few months is going for full lockdown is quite a clunky way of trying to implement social distancing.

“The challenge with going full lockdown is then it's not clear how you ease it, which is what the UK government has been struggling with in recent weeks.

“So I think there will be a different, a more nuanced approach from government in containing the virus going forward.”

Robin Parbrook: “If you assume the first bit of Covid was a tsunami, I think we will get secondary ripples, providing we all wear masks and do some social distancing.

“You will get these localised outbreaks and partial lockdowns, which is what we've got in Melbourne and Hong Kong.

“But putting in a countrywide lockdown would be catastrophic for the economy because it would just be psychologically so damaging.

“So I think we live with d lockdowns until we do get proper vaccines or the virus burns itself out. But it's not lights out or the end of the world as some of the pessimists are trying to portray.”

What lessons can we learn from previous crises?

Robin Parbrook: “I lived in Hong Kong during the SARS epidemic in 2003, when we had to lockdown we couldn’t work because we didn't have broadband, we didn't have the systems. We all came back to the office pretty quickly and the world returned to what it was pretty quickly.

“So the lesson learned this time is that it's different. This time around we have proved you can do working from home.

“This crisis reminds me more of the Asian financial crisis and the global financial crisis, because we are seeing something structural happening.

“It is creating significant winners and losers in stock markets, which is why you've seen this huge skew in performance within the stock market.

“For instance, if you go to the City of London, things are dead. If you own a restaurant or bar in the city, you're in big trouble. And if you own the property that houses those restaurants and bars, you're in even bigger difficulty, because you've probably sitting on a lot of debt.

“You are looking at assets that need a high level of utilisation that are now probably structurally impaired, because I don't think we are ever going back to 9:00 to 5:00 working.

“It is going to create quite a lot of disruption.”

Johanna Kyrklund: “I've seen some people make comparisons between this crisis and what other people call event-driven bear markets - things like the 9/11 terrorist attacks that caused a correction in the market. In those cases you had a very rapid V-shape recovery (a sharp fall followed by a rapid bounce back).

“I think comparisons with those crises are misplaced. Clearly, events like 9/11 were exogenous shocks just like this one, but the nature of something like 9/11 was more localised and also not as protracted. This crisis is more akin to the global financial crisis in terms of its potential impact of duration.

“But the way the market has behaved suggests that this is a short sharp V-shape recovery, just like an event-driven bear market. That would imply that the bear market ended in Q1. I don't think that it is quite simple as that.

“Ultimately, I don’t think we have fully grasped that this virus will be lingering into the autumn and that economic activity will be suppressed for quite a while.”

If we’re not going in to full lockdown, what role will governments play going forward?

Robin Parbrook: “It is clear governments are moving towards a different world of big government, so something more akin to the 1930s perhaps, 1950s, 1960s, 1970s.

“Governments will effectively take control of banks, and that means you stop the market clearing in many sectors. So you create effectively zombie companies. That is quite similar to what we have in China.

“I used to always get asked back in the 90s, ‘Why is the Chinese stock market always such a lousy performer?’ Because most Chinese companies were state-owned and heavily state-influenced, so you never had market clearing. It was capitalism with Chinese characteristics. That is probably what awaits us in the West.

“The message you take from that as an investor is perhaps be wary of companies that have taken government money. So it narrows down the areas you want to play in. The market, to some extent, is already anticipating that.”

What is next for markets?

Johanna Kyrklund: “Central banks have made it clear that they have no plans to tighten liquidity for the foreseeable future. That is quite a major underpinning for markets.

“That leads me to imagine the path of least resistance is for markets to get a bit more expensive and  there's probably a bit more of a way to go.

“I would still be favouring those areas that benefit from liquidity as opposed to more cyclical areas, because investors can't ignore the risk of a second wave in the autumn.“

Robin Parbrook: “There's certain sectors where we're seeing a high level of retail investor participation, and it's pushing valuations up and the stocks aren't reflecting any fundamental underpinnings. We refer to them as the 'BEVI' stocks.

“BEVI relates to stocks involved in biotech and pharma with no revenues and a pipeline of hopes and dreams. EV, which is any stock that makes a widget, valve, semiconductor, battery that might be used in an electric vehicle. And internet and any tech companies that can claim they have an internet, cloud, e-commerce, working from home, mobile gaming angle.

“What we're seeing in Asia is that any stocks that can claim to have these angles have basically gone ballistic, particularly in China, Taiwan, and Korea.

“There are good stocks in those sectors, and this is where you do get some parallel to the TMT (technology, media and telecoms) bubble of 1999/2000. But we are seeing irrational exuberance and investors should tread carefully.

“Some businesses will die. Some will become zombies. But some, because necessity is the mother of invention, do reinvent themselves.

“There might be opportunities in some of the adapters, things like convenience stores, some of the retailers that can get their websites up and running, because they are going to see big rent reductions as well.

“Some of the leisure names because people will travel again. Business travel may be structurally impaired, but I do think leisure travel will return. So look for opportunities - don't throw your babies out with your bath waters.”

Johanna and Robin were speaking on Schroders’ Investor Download podcast.