01 February 2020 Commentary

The coronavirus was a highly unpredictable event, yet investors always knew that something would cause a recession to interrupt the present bull market. Since late 2018 there have been a number of warning signs including: the Fed overtightening of interest rates, the yield curve inverting, and the New York Fed Probability of Recession Model, which has been right each time since 1968.

Economic and earnings forecasts, which are of little use at the best of times, are hopeless at present while the cloud of uncertainty is heaviest. Financial markets are the best predictors of recession, in large part due to their reflexive nature. As they fall investors and consumers lose confidence, making a recession ever more likely, leading markets to potentially fall further. It is this confidence spiral which needs to end in order for markets to find a floor – either through policy intervention (by directly addressing the virus, or financial markets to a lesser extent), or through stocks falling further and finding a clearing price

Despite the fall, equities are still expensive compared to historic levels while, concurrently, they are incredibly attractive compared to most alternatives. This gap between the fair value implied by historic valuations (10-20% lower) and the fair value justified by a lower opportunity cost from owning cash or bonds (c.50% higher) is an ever widening no man’s land filled with fog. It is our view that markets are likely to fall lower towards their historic valuations until such time as clarity prevails, when the upper bounds of possibility will reassert themselves. As a result we trimmed our equity allocation and increased our cash holding recently, and will be looking for further market weakness as an opportunity to initiate new positions.

Bond yields are now effectively zero across the world and, even if earnings fall 20%, stock markets will have an earnings yield of 5% at today’s prices. These earnings are implicitly inflation protected and will grow through time, at least in line with GDP. Many individual stocks which are potential investments for the Horizon Fund are already more attractively valued and offer higher potential growth.

The stock market is alive with opportunities, and it is the only remaining asset class with a long term positive expected return. In 2020 investors need to decide when, not if, to reallocate some of their portfolios to equities.

NB Markets are moving fast and stock markets have fallen again in March. To the 9th March the FTSE World Index (£) has fallen -9% and the fund is down -2%.