Fight or flight? When ‘black swan’ events happen
When unsettling events such as the coronavirus (COVID-19) outbreak and market volatility dominate the news, it’s natural for investors to question and second-guess their investment strategy. As hard as it is to do nothing, it will serve investors best not to flap about in disarray, focus on the facts and remain calm.
What is a ‘black swan’ event?
A ‘black swan’ is an unpredictable event that is beyond what is normally expected of a situation and has (potentially) severe consequences. Black swan events are characterized by their extreme rarity and their severe impact. In recent weeks the global economy has been faced with two black swan events – the ongoing coronavirus and the unexpected Russian assault on oil prices, sparking volatility in markets and anxiety in investors.
In our opinion, both these situations will resolve themselves in time. However, the big debate across the country, and the globe, is around the issue of the medium-term economic impact and where-to-from-here? The reality is that periods of short-term volatility are inevitable and shocks to sharemarkets are not unusual. Even so, these types of events create uncertainty and often leave investors with the urge to do something.
Focusing on valuations is key
It is too early to assess whether the coronavirus outbreak will have a long-lasting negative impact on the global economy, but we believe immediate evidence points to a short-term impact (assuming health officials are successful at containing the outbreak).
If the impact is short-term, price declines have created buying opportunities and some asset classes have emerged as attractive to us. Warren Buffett, chairman and CEO of Berkshire Hathaway, has recently said “you don’t buy or sell a business based on today’s headlines. If the market gives you a chance to buy something you like and you can buy it even cheaper, then it’s your good luck.”
Oil price wars adding fuel to the fire
The second black swan event (which was most prevalent in the markets on Monday 9 March 2020) was the surprise and significant fall in oil prices. The decline was mainly caused by the inability of the OPEC+ alliance/cartel to agree to cut production, following the global slow down brought about by the Coronavirus. Instead, two of the largest oil-producing countries (Russia and Saudi Arabia) increased output, which led to a complete oversupply of oil, resulting in the significant drop in the oil price.
In our opinion, the dramatic move in the oil price is a short-term occurrence and we foresee prices returning to a more normalised level once coronavirus pressures have declined and growth fears start to abate.
When is the right time to buy assets?
Anyone that proclaims they know the perfect time to buy is likely lying or has been very lucky.
Our approach is to focus on probabilities: we change our positioning according to how extreme an asset is priced. In other words, we may buy an asset if we find it is attractively priced; if its price falls, we may buy more because—all else equal—it would have grown more attractive. We buy when we are being rewarded for the risk of taking on that investment.
What portfolio changes have been made?
The current volatility has, once again, highlighted the importance of effective portfolio management, asset class diversification and pricing in risk to protect capital.
Heading into this period of volatility, we had been positioning our portfolios away from the most expensive asset classes and markets, favouring better priced investments and cash. However, since the market volatility began in late February, we have seen rapid and meaningful declines in Australian and global sharemarkets. We have seen indiscriminate selling, with all global equity sectors recording losses regardless of their underlying fundamentals. With these declines, we have taken the opportunity to increase the portfolios’ exposure to growth by adding to Australian and global sharemarkets, most notably global energy shares, which have seen dramatic price declines.
Considering taking flight?
There are always reasons not to invest, however, take a moment to reflect over the past 100 years. We’ve been through two world wars, over a dozen recessions, a financial crisis, and a Great Depression, to name a few. Put in this context, the coronavirus fears are likely to eventually pass. We have seen governments and central banks around the world responding to the coronavirus impacts on the economy through massive spending programs and lower interest rates.
While the consideration to move assets to cash is an understandable response to recession fears, we believe that investors should stay focused on their long-term financial goals and remain calm.
Over the past decade, we have seen a steady rise in global sharemarkets; most notably, we have seen the longest rise in U.S shares in history. It is important to remember that there are times when markets can and do fall, and that market declines are a normal part of the business cycle. While market weakness is uncomfortable, it is important to keep a focus on the long term, rather than be distracted by short term events.
We are closely monitoring markets and the portfolios to ensure that we take opportunities to buy good assets at cheaper prices.
