Children of the Revolution – Part 2 – How do we Get Out of This Place?

Quoted in the FT, hedge fund manager Mark Spitznagel said, “Good luck to anyone that just tries to copy an old playbook in this crisis … We think we had the last crisis all figured out, retrospectively, and so we think we’re so smart in the next one. It just doesn’t work this way.”

From the analysis presented in Part 1 it should be clear that we think the result of this crisis will be certain pre-existing trends will be strengthened.

The shift of the economy online, a greater concern for keeping trade relations local, and increasing regulatory interference in banks and raw materials should be enduring effects.

‘Technology’s centrality to our lives will be strengthened and this will be felt in the stock market’

Technology’s centrality to our lives will be strengthened and this will be felt in the stock market. In that light, exposure to a specialist technology trust seems attractive in any future scenario.

Allianz Technology Trust (ATT) and Polar Capital Global Technology both performed much better than the average US or Global equity fund during the drawdown we have been examining, with losses of 16.7% and 16% respectively.

We will be publishing an updated note on ATT in the coming weeks – please click here to register your interest.

That is perhaps the major long-term lesson of the crisis, but a lot remains extremely uncertain with different investment implications. We see two ways forward from here.

Outlook

1. Optimistic scenario

There are good reasons to be optimistic. In the optimistic scenario, as our understanding of the virus grows, the likely fatality rate declines.

UK and US authorities believe the rate to be below 1% and it could well end up being close to the 0.1-0.2% of seasonal flu.

If the current testing regime shows that the virus is more prevalent than previously thought, and the fatality rate therefore lower, we could see restrictions on movement beginning to be lifted in May.

In this scenario, the retail and leisure parts of the market would return to business earlier (if not immediately) and the number of defaults and business closures will be limited.

Trusts which depend on such areas for dividends might miss just one payment.

‘There could be huge potential in a short term rally in trusts that are exposed to UK domestics’

There could be huge potential in a short term rally in trusts that are exposed to UK domestics.

These companies were cheap heading into 2020, thanks to concerns around Brexit, but had started to pick up as the outcome seemed likelier to be managed.

We see no reason why most of those gains should not be made back.

Sterling looks cheap relative to euros and dollars, so managers with greater UK exposure could benefit.

There could also be quick bounce backs in trusts with energy and materials exposures, and our feared government interference in the banking sector could be limited.

The rise in UK government debt would be relatively limited and the government could take the ‘austerity’ way out (as it did after 2008, but also after the large debt build-up which followed the Napoleonic Wars).

2. Pessimistic scenario

In a pessimistic scenario, the serological tests show that few of us have had and recovered from the virus.

Lockdown is likely to last for months, and more and more businesses will exhaust government schemes and then go under.

Restaurants and bars will become less frequented, and this trend will last for years as consumers remain frightened.

UK government debt will increase as firms taking government loans go bust.

‘the longer the lockdown lasts, the more likely the loss to potential GDP growth will be permanent’

We would suggest the longer the lockdown lasts, the more likely the loss to potential GDP growth will be permanent and the harder it will be for the government to make nominal GDP rise higher than its interest payments.

Inflation would then be more likely to seem like the only way out for the state (as it did after the second world war) and cash savers would suffer.

The underperformance of value would be exacerbated, and banks and energy companies in particular would struggle.

Trusts with higher technology weightings would continue to outperform, but may well do so in either scenario over the longer term.

Bonds would finally meet their nemesis.

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