What caught my eye this week.

Remember a thousand years ago – or more precisely, in March – when we watched with horror news stories of Italian hospitals overwhelmed with patients and footage of sullen families barricaded inside their homes?

I think most of us failed to connect what was happening on TV with what could happen here.

Oh, I understand not you – you saw it all coming.

Me too, of course, as I’ve banged on about for months.

Well… maybe.

The truth is it’s very hard to truly envisage a reality revamp until it slaps you in the face.

In mid-February a good friend of mine was banging her head against the wall because all the factories she dealt with every day in China had shut-up shop. All of them!

In theory I knew this from the financial news – I’m a stock market junkie, after all.

What’s more I’d had a morbid fascination since January with what we then called the ‘novel coronavirus’.

But it wasn’t until I saw my friend despairing for her business – right there in front of me – that I truly weighed up what would happen if the virus got here. And then I sold some shares.

I think we’re in a similar place with the economy.

Look out below

Most people now understand that a lockdown craters the economy. The statistics are coming in every day – I’ve included a few in the links below – so it’s impossible to refute.

The debate now is how quickly we can bounce back, and to some extent whether it will prove to have been worth it.

But I don’t think any of us are really processing what this graph might look like in real-life:

The graph comes courtesy of the Bank of England, which this week told us it expects GDP to decline 14% in 2020 as a whole before rebounding 15% in 2021. It will be the worse slump for 300 years.

Does it yet feel like the worst slump in 300 years to you? Are we all so sanguine because we’re confident we’ll see the same ‘V’ that the Bank of England is sticking up in front of us?

Or are we not actually thinking about it?

Will we even get such a strong bounceback, after such disruptive chaos?

Economic forecasting is a thankless task and I don’t envy them their job, but these guys haven’t exactly covered themselves with glory with their predictions over the years. Anyone who has followed the inflation target saga can tell you that.

I do hope we’ll see a ‘V’, and provided Covid-19 quietens down it’s what you’d logically expect. Whatever the pros and cons of our economy, the recession we’re in wasn’t precipitated because the economy was structurally overwhelmed. It’s more like a storm that superficially smashes the place up (the pandemic), as opposed to dry rot that ruins the foundations from the inside out (sub-prime mortgages or dotcom valuations or over-powerful unions or too much crappy investment or whatnot).

If the big bazookas being fired this way and that by the Government and the Bank of England have done the trick, we’ll have stunned the economy senseless for three months, but we could emerge something like how we went into it.

If…

The new most hated rally of all time

Time will tell. As for the stock market, I’m still not as offended by the rally as most people.

Central Bank action has lopped off the truly disastrous tail risks that the market was facing in March.

After that, the shares that have rallied the most are by far the superior companies. As I’ve mentioned before, in many cases they’re companies directly benefiting from global lockdown Even where they’re not, their valuations are typically based on earnings due far into the future.

In contrast, the hardest hit firms are mostly still in the dumpster.

Also consider when exactly we’re likely to see meaningfully higher interest rates.

I have I hard time imagining UK Bank Rate reaching even 2% by 2030. Anything is possible, but for reference a 30-year gilt is currently yielding 0.53% so don’t hold your breath.

I bought my flat after a decade of prevarication and got my stupidly big mortgage because I finally became convinced rates weren’t going anywhere in a hurry. That was more than two years ago. Now future rate rises will take the extra-scenic route, and stop off in every quaint village along the way.

Companies that survive the imminent recession are almost certainly going to do much better than cash in the bank over the next 10 years. If some of the world’s 1% have the spare money to buy them now while they’re still – just about – on sale, is it any surprise?

Of course markets can do anything, so it equally wouldn’t surprise me if we saw the indices halve again by Christmas. I’m just saying I don’t think the rally is unjustified.

Anyway have a great long weekend, and I hope neither the virus nor the counter-measures have laid you too low!

[continue reading…]

What caught my eye this week.

Mixed events in the global soap opera saga Coronavirus this week.

The good news is the Prime Minister returned from that episode to tell us we’re probably past the peak of Covid-19.

The focus now is on R, aka the reproduction number. Keep it under ‘1’ and the pandemic is not spreading exponentially.

As a nation our R number is now somewhere under 1. Probably between 0.5 and 0.75, although it may still be higher in some places like (tragically) care homes.

Ruh-Roh

The lower the R the better, obviously, but the question will increasingly be how much more [insert what matters most to you] damage we can take to lower it further?

Getting R down from the 3 to 4.5 level that looked like it might overrun the NHS was a no-brainer. But there’ll be diminishing returns.

Full lockdown – or even just heavy social distancing – has health as well as economic consequences, too. Some people will die earlier because we brought a recession upon ourselves.

Yet equally, every micro-notch higher in R that we accept means someone somewhere will die before their time from Covid-19.

That’s the equation for the upcoming weeks.

There are no easy answers. Perhaps there was a more promising hypothesis, but the past seven days looks to have done for it.

Spread ’em

I’ve been mildly obsessed with Covid-19 since January (and mildly infected, I believe, in early March). I’ve ridden a rollercoaster from being precociously concerned to evasive action to believing things might not be as bad as was thought and now I’m halfway back again.

Long story short1 a series of intuitions (or guesses, if you prefer) informed by endless reading about Covid-19 convinced me the virus was spreading far faster in the UK than was generally thought likely.

All the experts knew the virus was spreading more quickly than reported cases, of course. But I (no expert) believed it was circulating faster again.

That was a comforting thesis because it suggested (1) the virus wasn’t as deadly as even the more middling predictions suggested and (2) we might reach some level of herd immunity sooner rather than later.

It’s long been clear this virus has a Great White Shark’s nose for the elderly and vulnerable, and I’ve been frustrated we either couldn’t or didn’t shield them better.

But in a super-infectious scenario, for the vast majority of us Covid-19 would be a very mild infection, mostly asymptomatic.

And by the time full lockdown was called, I felt it was possible a large number of us in London at least had already had it.

That proved to be right… a bit.

Peak deaths for the virus occurred in early April. Working backwards gets you to peak infections towards the end of the second week of March.

But how many? For that we can first consider deaths.

It’s hard to unpick the roughly 30,000 or so excess deaths we’ve seen so far in England and Wales in 2020.

Most will be due to Covid-19, but some may have been attributed to the virus incorrectly. For example, there were fewer heart disease related deaths in March. Perhaps some were blamed on Covid-19?

But just crudely guessing 30,000 and assuming an infection fatality rate (IFR) of 1%, that gets you to three million or so infected, with peak infection probably occurring in or around the period of voluntary lockdown, but just before mandated lockdown.

So overall millions have been infected – but not enough to be good news.

Unless… the IFR was much less than 1%, because far more people had been infected?

Start spreading the blues

That left antibody testing carrying the baby.

The hope was antibody testing would reveal that in areas of rampant morbidity to the coronavirus – such as Italy, London, and New York – many, MANY more people had been infected.

If this was true then you could indeed pull down the IFR.

Well, over the past seven days we got the first large scale data – from New York City and Stockholm – and it’s probably not good enough.

The New York City testing is the most promising, implying 25% of its citizens have had Covid-19. However, while that shocked the media it was much lower than I’d been hoping for.

Indeed as reader @Vanguardfan points out, 25% implies an on-consensus IFR of around 1%, if you take into account the number of presumed deaths to Covid-19 in New York City.

And 1% is no comfort if you apply it to the UK’s population of 67 million.

Now, not every last citizen will need to throw the viral dice – we should get some natural resistance to the virus on a population level, before everyone has had it.

However if we assume the chunky herd immunity thresholds that most experts think we’d need to see – at least 50%, possibly more like 70+% – even New York is far from having ‘earned’ an inherent resistance through its deathly exposure2.

This is disappointing to me, though it won’t be unexpected to the experts. It looks like they called it.

Hopium

Much is still unknown about this virus. For every potential fact I find in early research about it, you can retort with another. Anyone waiting for scientific confidence (proof, for shorthand) better have a lot of series lined up on Netflix.

The huge list of Covid-19 links below (perhaps 20% of what I’ve read this week) gives just a taster.

It’s possible that amid this uncertainty there may be other off-ramps from the bad (though not worst-case) scenario:

• Maybe a large number of people can kill the virus with their immune system so easily that they don’t develop antibodies.

• Or maybe it’s spread much more widely among the most vulnerable parts of society, which is terrible news right now, but may have elevated the fatality rate and hopefully left the survivors with some resistance.

• Summer could well curb the spread anyway, which at the least should give us time to better prepare for any resurgence.

• Maybe the herd immunity threshold will prove lower than presupposed.

• Or more likely it may turn out that just a few key social distancing actions – no handshakes, avoiding crowds indoors, and washing your hands – will do 90% of the R-lowering. (The Swedish approach.)

• Kids may not be infectious, too, taking them out of the equation altogether.

I have reasons for making all those suggestions, based on my own reading.

But the truth is there’s an equally long list of reasons to be pessimistic.

As Freddie Sayers concludes in a sober piece on UnHerd that pits Sweden’s top epidemiologist against our own leading figure:

…it’s time to stop pretending that our response to this threat is simply a scientific question, or even an easy moral choice between right and wrong.

It’s a question of what sort of world we want to live in, and at what cost.

An ‘ell of a recession

Bottom line: I no longer hope for a very quick exit from this nightmare, unless perhaps R collapses extremely rapidly in the next few weeks and we can go back to trying test and tracing.

And this probably kicks the V-shaped recovery into the long grass. The drag from physical distancing and other anti-viral precautions alone could knock a few percentage points off GDP, even if we go back to semi-normal.

What are football matches, trade conferences, pubs, easy air travel, and the Glastonbury Festival worth to GDP, to name but a few lost causes?

Even if fatal Covid-19 cases do plunge and more normality can be reinstated, for as long as outbreaks flare up it may be hard to persuade some people to take their chances.

We’ve been bombarded with deathly warnings about the virus and kept under house arrest for a couple of months on its account. Dinner and a show on Friday night? Many may continue to Deliveroo and chill instead.

And while a cocktail of better treatments (drugs and regimens) will probably be assembled by the end of the year, that’s, well, the end of the year.

So L-shaped recovery it is. Probably what’s priced in by the global stock markets, anyway.

You see, a lot of people are talking about market mania after the quick bounce from the March lows.

But this is mostly a US market thing. And in the US market it’s mostly a tech thing. And of the tech companies, it’s mostly a bunch of cloud giants who couldn’t have come up with a better driver of demand than ‘shelter in place’. Strong demand now, plus their valuations turn on the years of prodigious earnings they’re expected to make long after Covid-19.

No, if you want a market that’s geared to the global economy, look to the UK’s FTSE 100. Its 2020 performance (red) already looks like an ‘L’, versus the (blue) S&P 500’s squint a bit ‘V’:

Source: Yahoo Finance

I’ve always been more worried about the financial impact of global lockdown than most, even while I was slightly more sanguine about the virus.

And now I see economy-dinging restrictions continuing.

So I’ve a horrible feeling that while the UK pandemic probably is past its peak, with the economy it’s like we’re back when people were gasping at footage of Italians stuck inside, hardly realizing the sort of misery we’d soon face.

Note: Fed up with virus chat? I’m planning to drastically reduce the number of Covid-19 links here next week. We’ve just hit that peak, too!

[continue reading…]

1. Read the past two months of Weekend Reading comments for the real-time discussion! [↩]
2. Presuming such an immunity actually exists, which isn’t definitively proven, but which seems likely. [↩]

I noticed a few of the wilier cats among the Monevator crowd were holding US government bonds going into the coronavirus crisis. They seemed pretty pleased with themselves, so I decided to see what’s up.

After all, there’s no better time to change your strategy than after the horse has bolted…

Most of the passive investing gurus advise holding high-quality domestic bonds (i.e. gilts, if you’re a UK-based investor). But then, most of the passive gurus are from the US. What if there’s some kind of American Exceptionalism playing out here and I’ve been a Lee Harvey Oswald-style patsy all this time?

To assuage my fears I logged into the ETF-screening and portfolio-building service, JustETF.

I compared unhedged1, intermediate government bond ETFs of the US, Euro, Global, and UK persuasion.2 I pitted them against each other and an MSCI World ETF during as many stock market bloodlettings as possible. My fears were un-assuaged.

Coronavirus Crisis – government bond comparison

The yellow line is why those Monevator cats are purring about their US Treasury bond holdings.

World equities hit bottom on 23 March. Our team of high-quality government bond ETFs were all straining in the opposite direction that day – stopping our portfolios and us jumping off the ledge.

Some did more work than others, however. As world equities clocked a loss of -26.4% (relative to 20 February), the bond ETFs countered with gains of:

• 4% – Intermediate UK Gilts (Blue line; ticker: IGLT)
• 7.6% – Intermediate Euro Government bonds (Red line; ticker: IBGM)
• 11.9% – Intermediate Global Government bonds (Orange line; ticker: SGLO)
• 17.7% – Intermediate US Treasury bonds (Yellow line; ticker: IBTM)

Gilt returns peaked on 9 March and then the pound slid 12% through to 23 March. Gilts turned negative on 18 to 19 March while overseas bonds were buoyed by the falling pound. The Euro has fallen away since, but US Treasuries are still up 11.9% to gilts’ 5.3% on 24 April.

Consider my interest piqued.

Global Financial Crisis (GFC)

The same ETFs are back in play bar the global government bond effort (it was only launched in the midst of this crisis).

The world turned dark on 6 March 2009 with losses reaching -38%.3 Thankfully our bonds would have offered a ray of hope:

• 18.6% – Intermediate UK Gilts (Blue line)
• 47.7% – Intermediate Euro Government bonds (Red line)
• 73% – Intermediate US Treasury bonds (Grey line)

The pound took a beating against the US dollar in 2008 and, though it recovered some ground in 2009, by the end of the crisis the US Treasury bond ETF was up 62% versus 57% for the Euro gov bonds and 16% for the gilts.

Clearly we’d have all slept more soundly with US Treasuries in our portfolios.

Incidentally, notice that shark’s jawbone image you get when you compare the grey line’s upward flex versus the orange line’s downward gape from October 2008 to August 2009. That’s what textbook negative correlation looks like and that’s why we hold high-quality bonds in our portfolio.

European Sovereign Debt Crisis

The world was down -14.9% on 2 Jul 2010.4 By that day our bond ETFs had responded with:

• -2.1% – Intermediate Euro Government bonds (Red line)
• 4.6% – Intermediate Global Government bonds (Orange line)
• 5.2% – Intermediate UK Gilts (Blue line)
• 9.1% – Intermediate US Treasury bonds (Yellow line)

Okay, Euro Government Bonds were not the place to be during the European Sovereign Debt Crisis. Fair enough. Once again US Treasury bonds proved to be the safest of safe havens, though there was less than a percentage point in it by 13 December 2010.

It’s starting to feel a bit voyeuristic – like I’m some kind of rubber-necking vulture looking for another carve-up.

Still, why stop now when we’re having fun?

2018 Global Stock Market Downturn

World equities delivered an unwelcome Christmas present of -15.9% in just a few months to 24 Dec 2018.5 Bonds took until 3 January to respond properly, after the sales were in full swing:

• 1.5% – Intermediate Euro Government bonds (Red line)
• 1.7% – Intermediate UK Gilts (Blue line)
• 4.5% – Intermediate Global Government bonds (Orange line)
• 6.4% – Intermediate US Treasury bonds (Yellow line)

Again US Treasuries were the place to be in comparison to gilts.

JustETF doesn’t have the data to take me back further in time. But if the last 12 years’ worth of downturns are anything to go by then I have just one question…

Is this a thing?

US Treasuries look better than gilts for UK investors when it comes to stock market crash protection over the last decade and more.

But it’s also nice if your assets provide long-term returns, so let’s see how our options stack up on that score:

US Treasuries win again.6 Not by a devastating margin, but you wouldn’t say no.

And there’s certainly a rational story to justify holding US government bonds. America is the global superpower and the dollar is the world’s reserve currency.

Why wouldn’t everybody run into the arms of US Treasuries during a meltdown?

Moreover, the pound is described as a pro-cyclical currency: it tends to fall when the global stock market falls. In which case, you might well expect to see an exaggerated spike in US Treasury returns (as measured in pounds) at the very moment equities nose-dive, especially as currency volatility is meant to dominate government bond returns.

Wait! Let’s get a longer-term perspective

A portfolio is for life, not just for bear markets.

This table comes from the Sarasin Compendium Of Investment, albeit from 2012. It shows that US Treasury bonds are far from a no-brainer for UK investors when viewed over a different timeframe. 

This comparison of 10-year government bonds shows that UK investors averaged a return of 8.9% per year versus 7% for US Treasuries of this period when returns are measured in pounds (see the Sterling Return column).

Notice that in 1987 – the year of the Black Monday Stock Market Crash – US 10-year government bonds returned -19.7% in pounds, whereas gilts brought home 15.5%. The falling dollar wiped out 21% off the return of Treasuries.

Global equities suffered another set back in 1990 as Saddam Hussein invaded Kuwait and Japan entered its multi-decade slump. Gilts spiked 9% while US Treasuries dropped -9.5%. Unhedged currency exposure backfired again, this time to the tune of -16.7%.

So. Maybe this special relationship isn’t all one-way.

The monumental returns of the 80s and 90s (I weep that I was in short trousers not the market then) ended with a pop as the dot-com bubble burst. US Treasuries trounced gilts in 2000 and 2001, but suffered a reversal in 2002.

If you scan your eye down the Currency Effect column, you can see from the size of the effect versus return that most of the differential between gilts and US Treasuries (sterling return) is explained by exchange rate volatility. 2008 was the annus mirabilis as the currency effect added 57.7% to the year-end return of US Treasuries.

Still, it’s surprising to see that gilts came out on top over the whole 15-year period.

It’s a struggle to go back much further than this with the data we have access to. We do know that the 1970s oil crisis smashed up global equities in 1973-74 and that UK equities suffered their worst loss on record during this period: -71%. Gilts were a car crash, too, going down 50% between 1972 and 1974.

Meanwhile, the pound lost just -1.28% to the dollar in 1973 and then gained 1.29% in 1974. I highly doubt you’d have noticed that shimmy, what with the oil crisis, recession, double-digit inflation, miners’ strike, the Three-Day Week, and general elections every five minutes.

Did any Monevator readers have market exposure during this one? I was there but my only assets were a £5 Premium Bond, a romper suit, and dimples.

Where does that leave us?

Good question. Opting for US Treasury bonds is a currency play for UK investors pure and simple. You’d be betting on the pound falling against the dollar as investors head for the safe haven hills.

Despite recent history and the supremacy of the States, events don’t always unfold as expected. I read a couple of research papers that said the Euro was a reliable safe haven until it wasn’t. And of course, we’ll only find out that reality is no longer following the script at the worst possible moment – when we need diversification the most.

Multiple papers concluded that UK investors should hedge any global bond exposure they have, including this report from Vanguard:

In Figure 10, we examine the performance of unhedged global bonds, hedged global bonds, and local market bonds in the bottom decile (the worst-performing 10%) of monthly returns for the global equity market. We find that hedged global bonds provided more consistent returns and in many cases better levels of counterbalancing than local bond markets. Unhedged global bonds, on the other hand, had a much wider range of returns and in the majority of cases did not provide similar levels of diversification.

Thus, hedging away the currency risk is necessary if global bonds are to provide the maximum level of diversification and fill the traditional role of high-quality bonds in a balanced portfolio.

Ultimately, I’m a passive investor because I want to keep my investing life simple. I’m unlikely to be agile or informed enough to know if there’s no longer good reason to believe in the dollar as a ‘risk-off’ currency.

Yes, I get my head turned when I come across a fund that would have been amazing to hold these last few years. But by the time I’ve found out about it, it’s already too late.

My portfolio is built for the next 40 years (I hope) and I believe it’ll get through the next 40 months just fine.

Take it steady,

The Accumulator

Bonus chart: August 2011 stock market downturn

After I finished the post, I had a nagging doubt I’d missed something and here it is. The oh-so memorable August 2011 slump. At last there’s a recent-ish downturn when US Treasuries didn’t completely dominate gilts. World equities had their darkest hour on 19 August 2011 bottoming out at -18.7%.7 Gilts topped the charts that day:

• 1.8% – Intermediate Global Government bonds (Orange line)
• 2.4% – Intermediate Euro Government bonds (Red line)
• 3.7% – Intermediate US Treasury bonds (Yellow line)
• 5.1% – Intermediate UK Gilts (Blue line)

US government bonds had nudged slightly ahead by the time equities nosed into positive territory on 13 March 2012. In reality it was neck-and-neck with US Treasuries on 11.2% and gilts on 10.9%.

1. i.e. Not currency hedged. [↩]
2. Long bond ETFs would be more dramatic but we’ve never recommended them here due to the potential losses from interest rate rises. [↩]
3. Relative to 12 October 2007. [↩]
4. Relative to 15 April 2010. [↩]
5. Relative to 29 August 2018. [↩]
6. The 6 March 2009 start date is defined by the launch date of the youngest product in our line-up: iShares Global Government Bond ETF. [↩]
7. Relative to 8 July 2011. [↩]