“Why did nobody see it coming?” was the question Her Majesty asked in 2008 of the financial crisis. From an investment perspective it is always good to review successes AND failures. The phrase “nobody thought that…” has been used in our virtual conversations many times recently and it helps encapsulate some of the dramatic events over the first quarter of 2020.
Nobody thought that way back in early February a virulent virus in the Wuhan region of China would collapse the global economy. Today’s estimates vary but global GDP is expected to contract in 2020 by around 3% from a previous expectation of positive growth of around 3%. For the year overall we should expect a 6% collapse in UK GDP too, from around 1% growth forecast at the start of the year. To put it into context, it is the worst collapse since the post-World War One contractions in 1920 and 1921, and worse than 1931. As the 6.6m weekly increase in US initial unemployment claims shows, this is truly horrific.
And nobody thought that interest rates would be cut to zero in the US within a fortnight. The scale of central bank intervention is truly staggering and, for the UK, at 10% of GDP mirrors the announcement from the Bank of England in March 2009. The Bank of England is currently buying £13.5bn of gilts a week. We have witnessed other quite incredible events; nobody thought that a geopolitical OPEC spat between Russia and Saudi Arabia would take the oil price to $20, lower than 2016, and materially lower than 1986 when adjusted for inflation.
So it is no surprise to see that in the last 10 days US investment grade spreads have touched levels not seen in over 30 years. No one could have predicted a 100 point price fall in the longest index- linked gilt in 10 days (from 300 to under 200). Similarly, in a rapid and unprecedented turn, moral and real regulatory pressure was placed on banks with a suspension of dividends for many major banks across the globe. This provided anxious subordinated bond holders (e.g. AT1 bonds) further worry, albeit these coupons seem safe for now. As with any investments, a turn of events driven by politics rather than contract can have unintended investment consequences and strengthen the chorus of “nobody thought that could happen”.
As we write our reports for the first quarter we will recognize good decisions; long duration, reduced credit exposures along with bad decisions, including exposure to oil companies and retailers. Such has been the ferocity of moves and prices that positioning for 1 March could be spectacularly wrong by mid-month. Many rational judgements have been destroyed as March played through and events happened that nobody thought could happen.