What caught my eye this week.

The graph of this week’s GDP forecast from the Office for Budget Responsibility looks like something from a comic book:

That’s not an economic projection – that’s the punchline to a three-panel cartoon.

Of course the hope is that like a sack full of garden manure dropped onto a trampoline, what goes down must surely bounce up again. And it will. But how?

Will we see a V-shaped recovery? A U-shaped recovery? Maybe a W-shaped start-stop affair? Or even a Nike Swoosh?

The idea is to pick the letter of the alphabet that best fits how you expect the graph to go over the next few months.

Personally, I think it’ll probably be more like a Chinese character, darting up and down all over the place.

Modern economies are fabulously complex, and switching ours off wholesale will have broken numerous connections. When we restart, some areas will fly but others will be literally waiting for parts.

China tried to reboot its big factories first, but then discovered most of them relied upon smaller suppliers. So they were switched on, too – but then they found workers had nowhere to eat, because the street canteens hadn’t yet been allowed to reopen.

Britain on pseudo-FIRE

We’ve got plenty of time to think about all this, what with lockdown officially extended for “at least” another three weeks.

Indeed it seems that many Britons have become more reflective now their alarm clocks have stopped buzzing and they’re working within sight of their gardens and kids.

It’s bemusing to me to read articles or hear podcasts in which people gush about how proud they are to be managing to work from home.

Apparently it’s a revelation to many that the technology is available, and that people will get on with work without the clattering distraction of an office or the time suck of a commute.

Fifteen years ago I co-founded a company that eventually grew to dozens of employees and scattered contractors. We never had a central office and ran the thing using Skype, Gmail, and early on Google Spreadsheets.

We’d meet fancy clients in a London member’s club to avoid awkward questions. But mostly we plotted strategy around our dining room tables, and then beavered away in our homes.

It seems this is fairy story stuff for many workers. I’ve written before that I believe more things will stay the same than change post-Covid-19.

But maybe I’ve been presuming too much?

Sky News reports that only 9% of people want life to return to normal after lockdown:

The survey found that 61% of people are spending less money and 51% noticed cleaner air outdoors, while 27% think there is more wildlife.

Others say that having glimpsed the freedom of working from home, many won’t want to go back:

“Once they’ve done it, they’re going to want to continue,” said Kate Lister, president of consulting firm Global Workplace Analytics.

She predicts that 30% of people will work from home multiple days per week within a couple of years.

Lister added that there has been pent-up demand by employees for greater work-life flexibility, and that the coronavirus has made their employers see the light, especially as they themselves have had to work from home.

Indeed some are already anticipating a rearguard action from The Man and His Minions, who are presumed to be desperate to keep us in our (work)place and on the hedonistic treadmill.

In a widely-shared Medium article, Julio Vincent Gambuto celebrated the global lockdown:

The treadmill you’ve been on for decades just stopped. Bam!

And that feeling you have right now is the same as if you’d been thrown off your Peloton bike and onto the ground: What in the holy fuck just happened?

I hope you might consider this: What happened is inexplicably incredible.

It’s the greatest gift ever unwrapped. Not the deaths, not the virus, but The Great Pause.

It is, in a word, profound.

But Gambuto predicts capitalism won’t stand for it.

“We are about to be gaslit in a truly unprecedented way,” he says, using the neologism for manipulating somebody into doubting their own sanity.

Lock heeding martians

While of course I’m breezily doing as directed – it’s not a big weekday change for me, to be honest – I do have mixed feelings about the full lockdown strategy, as we’ve been discussing in the Monevator comments over the past few weeks.

Sweden, for instance, has no mandatory lockdown and yet far fewer deaths per million citizens, as cited in the links below. Indeed different countries are as figuratively all over the map with their Covid-19 pandemics as they are on the globe. It seems there’s a lot going on we don’t yet understand.

But all that aside, I’ve been moved by seeing the lockdown in action in London.

When China shut-up Wuhan, the few over here who were paying attention wondered whether we could ever manage anything similar in the individualist West. I admit I had my doubts.

Yet with no coercion and minimum fuss, the vast majority of us have followed the government’s strictures and it’s a little wonderful.

Out on my daily walk, every time someone steps off the pavement into the car-less road to give me space before I can do the same for them, I almost want to hug them. (Oh the irony!)

The London air is clean to breathe. You really can hear birds sing.

Even as the economy craters. Even as Romanian workers are being flown in to pick fruit because the farming industry still can’t find British workers to do it, despite a million more jobless than last month. And not even Covid-19 can slow down Brexit.

Irony indeed.

Have a philosophical weekend!

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One of the ‘joys’ of a market crash is that it enables us to test all those asset allocation theories in real-time. Yay!

A reminder: What we look to do when we construct our passive portfolios is to combine complementary asset classes. This way, when one asset is plunging, other assets will hopefully break our fall.

Diversification stops us placing all our bets on the wrong horse.

What often happens though is that people are not as diversified as they think, or they sack off investing in the more sluggish asset classes during – oh I don’t know – an 11-year bull market. Feeling over-confident, they shun the very asset classes that can stop you losing your mind when reality strikes.

Well reality has struck and then some. Did diversification work?

Diverse interests

If diversification really is ‘the only free lunch in investing’1 then we must have all had a belly full by now.

Let’s see how diversification has delivered even over a relatively short period.

I’ve tracked the impact of the crash on the main asset classes since global equities hit their 2020 peak on 20 February. All the returns quoted are measured from 20 February using Exchange Traded Funds (ETFs), and include dividends.

The ETF returns data and charts come from the excellent portfolio-building service JustETF.

100% equities during the coronavirus crisis

From that February high, global equities hit a low of -25.95% on 23 March. (To relive the panic, read this coronavirus crash edit culled from the Monevator comment threads.)

The markets have rallied since. They were only down -15.45% when everyone knocked off for the weekend on 10 April.

This glib summary understates the drama endured by anyone who stared in horror at this most shocking of bear markets. Many days over the period have seen wild mood swings. The situation has been volatile and movements more violent than normal. It’s been easy to be swept up in the emotion of it all – thanking the heavens for every rally and then wondering where the bottom is as we lurch back down again.

World’s. Worst. Rollercoaster.2

So far, so horrific for hard-charging investors committed 100% to global equities

But how did things look if you diversified into other equity sub-classes that are commonly held to be a good thing?

Equity diversification in a crisis – looks like this

Splendid, splendid. Everything and everyone was screwed!

All correlations ‘go to 1’ in a crisis, and all that. In other words, we all go down the toilet when markets are panicking, and there are no hiding places among equities.

You can see from the line of impact craters (28 February, and 9, 12, 16, and 23 March) that each market fell in lockstep, though the lead changes hands as if they’re a troupe of tumbling acrobats.

Global property and UK equities had the worst of it:

Global Property (the blue line, Amundi’s EPRA ETF)

• Low point: -36.56%, 23 March
• 9 April: -22.5%3

UK Equities (the red line, iShares’ ISF)

• Low point: -32.33%, 23 March
• 10 April: -20.59%4

Emerging Markets Equities are renowned for their volatility but haven’t bled as much as they did in 2008 so far… (orange line, iShares EMIM)

I looked at a lot of other markets for respite. It was all just various shades of the brown stuff:

US Equities (IUSA)

• Low point: -26.24%, 23 March
• 10 April: -14.17%

Global Dividends (VHYL)

• Low point: -27.96%, 13 March
• 10 April: -18.04%

Global Multi-factor (FSWD)

• Low point: -27.09%, 13 March
• 10 April: -15.33%

Global Momentum (FSWD)

• Low point: -23.57%, 13 March
• 10 April: -14.01%

Global Quality (IWFM)

• Low point: -24.97%, 23 March
• 10 April: -13.35%

Global Small Cap (WLDS)

• Low point: -34.5%, 18 March
• 10 April: -22.14%

The two brighter spots were:

US Tech: Nasdaq 100 (ANXG)

• Low point: -23.5%, 16 March
• 9 April: -11.68%

Global Low Volatility (XDEB)

• Low point: -21.12%, 13 March
• 10 April: -10.07%

As of 9/10 April, those last two markets show losses that are a quarter to a third less gruesome than global equities.

What does all this reveal? Mostly that equity diversification doesn’t stop your portfolio getting smashed in a bear market.

But it can still help. Your losses would be one-third higher right now if you were 100% in UK equities versus global equities.

But the real diversification benefit comes from other asset classes.

Long government bonds to the rescue

This is why we hold government bonds. As the stock market routs, high-quality bonds rally.

The chart above shows the famed flight to quality in action. As the mother of all recessions potentially looms, investors protect their capital by buying the bonds of countries that should be able to weather any storm, short of all-out disaster.

High-quality bond prices rise and cushion our portfolios from some of the damage born by equities, if we’re correctly positioned ahead of time.

Long-term, high-quality government bonds perform best in a panic. In the chart above you can see how a long-term, UK gilts ETF (GLTL) performed against our global equities ETF (VWRL).

In the first couple of weeks of the crisis, long gilts behaved impeccably. They peaked at 11.9% on 9 March, counterbalancing the slide of equities, even as the Saudis and Russians declared an oil price war. VWRL hit -18.46% on 9 March.

The negative correlation of bonds and equities does not work perfectly. Sometimes it does not work at all.

Equities and long gilts fell together like Holmes and Moriarty from 10 March. Equities slid to -25% on 16 March 16, and long bonds bottomed out at -5.32% on 18 March.

At least your bonds weren’t bombing like equities. But that would have been a hard week anyway you cut it, if you couldn’t pull your eyes off your portfolio.

Why was this happening? Does it matter?

Well, we humans like an explanation. A number of commentators described this phase of the crash as a liquidity crunch: financial titans selling off government bonds and even gold as they tried to cover their losses in equities.

Your best defence as a passive investor – dwelling far below Mount Olympus – is not to watch the war in the heavens. Ignore the daily drama and give your strategy time to work. A burnt offering or two wouldn’t hurt, either.

Long gilts rallied after 18 March to reach 8.52% on 10 April.

You can see that gilts and equities look broadly correlated with each other after the equity market bottom on 23 March. But the equities rally has only taken shares back to -15.45%.

Bonds in a crisis: short-, intermediate-, and long-term varieties

This chart illustrates the difference between short, intermediate and long-term government bond funds when faced with a recession.

As long as inflation isn’t your enemy, then long bonds tend to benefit most from the flight to quality. Their higher interest rates are a haven for investors as equities and interest rates swan dive.

You can see that the long gilt ETF (orange line) has offered the greatest crash protection overall, though it also fell hardest during the sell-off from 10-18 March. Long bond funds are considerably more volatile than their intermediate and short-term cousins. That’s written into the peaks and troughs of this chart.

The intermediate gilt ETF (blue line) has underperformed the long gilt ETF by over 40% as of 9/10 April, while the short-term gilt ETF (red line) barely registers life. It’s more like cash than anything else. That inertia is fine as far as it goes – short-term bonds will preserve most of your capital over brief timescales – but you don’t get a portfolio boost when you need it most.

The performance of the intermediate- and long-term funds shows why cash is not a good substitute for bonds in a crisis, defying the claims of many commentators who couldn’t see the point of bonds because interest rates just had to return to normal after the Global Financial Crisis. Ignore-the-crystal-ball-gazers, Lesson #497.

As with equities, I checked out some popular alternatives to conventional gilts for UK investors:

Global Government Bonds £ hedged (IGLH)

• High point: 4.32%, 9 March
• Low point: -1.13%, 18 March
• 9 April: 1.88%

Global Total Bond Market £ hedged (AGBP)

• High point: 2.3%, 9 March
• Low point: -3.45%, 19 March
• 9 April: -0.38%

The global government ETF is an alternative to the intermediate gilt ETF but has a shorter duration. That shows up in its relative underperformance in this crisis.

The total bond market ETF has a shorter duration still – half that of the intermediate gilt ETF – and it is also hampered in a crisis by some of its lower quality holdings.

The bottom line is that when the world is at panic-stations, a high-quality government bond fund will likely outperform its equivalent total bond market fund due to the flight to quality.

What about inflation-linked gilts and corporate bonds?

I’ve plotted unhedged, investment-grade global corporate bonds (blue line) and long-term inflation-linked gilts (orange line) against our intermediate gilt ETF (red line).

Neither sub-asset class should be expected to cover themselves in glory during a crash, and nor have they.

The inflation-linked ETF did awfully during the liquidity crunch that bottomed out 18-19 March, bringing home an equity-like -14.35% loss. Linkers are there to protect us from rampant inflation (think the stagflationary 1970s) but they’ve generally underperformed conventional gilts in deflationary recessions.

Inflation was definitely higher up most investors’ list of concerns than pandemics before now, so don’t go binning off those linkers!

That massive dump of fresh government debt that’s coming will have to be gotten rid of somehow. Inflated away, perhaps?

Just add gold

No disaster management post would be complete without examining the performance of gold.

The chart shows gold’s contribution to the imbroglio in comparison to global equities and long gilts.

Gold is a real loner of an asset class. You’d normally expect gold to plot its own path, indifferent to the concerns of equities and bonds.

Gold does tend to hold up when the bear is on the loose – doing so around four-fifths of the time according to Larry Swedroe’s review of the gold-as-safe-haven evidence. But it’s erratic. Gold was down 30% at its worst during the financial crisis, for example, before ending up 90% between November 2007 and February 2009.

Gold is doing its job right now. It’s in positive territory – not quite up there with long gilts but better than intermediates – and it bobs about to its own rhythms, acting neither quite like equities nor bonds.

I had a quick look at gold miners and broad commodities while I was as at it. They are regularly cited as plausible diversifiers in the passive investing literature.

Gold Miners (GDGB)

• High point: 4.46%, 24 February
• Low point: -27.22%, 13 March
• 19 April: -2.7%

Broad commodities (BCOM)

• Low point: -17.63%, 1 April
• 9 April: -13.32%

While gold miners and commodities may provide long-term diversification benefits, I don’t recall anybody claiming they would help in a panic. Sure enough, they haven’t.

Diversification vs 100% equities

Here’s the tale of the tape when you pit 100% global equities (green line) versus a diversified portfolio of global equities, intermediate gilts and gold (blue line).

This diversified portfolio is:

• 60% global equities (VWRL)
• 35% intermediate gilts (GILS)
• 5% gold (SGLN)

In other words, the kind of portfolio that many passive investors may well have picked. (I didn’t go for long bonds because only the very brave would have invested so heavily in them over the last ten years, though with hindsight you would have been handsomely rewarded for doing so.)

You can see for yourself which portfolio would have helped you sleep better at night. The diversified portfolio is still dominated by equities, so it’s still down. But most of us would be relieved to see losses of only 7% at this stage.

You can also see how a riskier Monevator passive portfolio with a different approach to diversification has fared during the crash.

Spoiler: it’s fine for now. I hope you are, too.

Take it steady,

The Accumulator

1. First called such in 1952 by Harry Markowitz, the father of modern portfolio theory. [↩]
2. Note, the flat-top rest points on the chart represent the weekends. [↩]
3. Last day JustETF are displaying data for, as I write this. [↩]
4. Last day JustETF are displaying data for, as I write this. [↩]

What caught my eye this week.

Having fortunately been relatively early into the pandemic pandemonium, I was also early out of it.

Share prices fell so fast that by the time most people had woken up to the economic catastrophe of a global lockdown and begun to panic, markets were already looking ahead again.

Much is uncertain, and who knows what will happen next. It usually pays to be optimistic as an investor though. If the short-term future is a coin flip I’d rather elect to be positive about the medium-term.

I certainly believe rampant talk of everything changing forever from Covid-19 is overblown. Far more will stay the same.

For example, while many are still writing the obituary for the cruise line industry, Saga has already booked two-thirds of its expected cruise revenues for September to January.

I’m pretty sure airlines will eventually fly everywhere again, too. And Instagram influencers will again queue for hours to take photos of themselves alone in beauty spots.

I’d be the first to agree the economic – and health – consequences of a protracted universal lockdown would be dire. Think Great Depression dire. But I actually believe they’d be so dire that we’ll have no choice but to modify our approach. (See my thoughts on that in the excellent discussion following last week’s post.) Any step away from deliberately stopping the economy and nailing on a deeper recession should be good for companies.

Hopefully this first – necessary – lockdown is buying us the time to calibrate a more sophisticated response going forward.

Dividends in doubt

Despite my tilt to the bright side, I’m not saying this is a storm in a teacup. It’s a storm in a storm!

Every day has brought something notable or unprecedented to a humble student of the markets – from scary volatility and weird dislocations to almost unbelievably bold Central Bank and State action.

But – putting the all-important health tragedy to one side on what’s mostly an investing blog – the thing that has really shocked me is the mass suspension or cancellation of dividends.

Many companies had no choice but to cancel, because they won’t make any money with the economy turned down to ‘2’. The banks and insurers have been all-but ordered not to pay a dividend. Other firms like Tesco have pushed ahead with a dividend, and been castigated as pariahs for it.

According to the latest Dividend Monitor from financial firm Link Asset Services:

• 5% of UK companies have already scrapped payouts to shareholders
• £25.4bn of cuts are sure to hit this year (one-third of the April to December total)
• A further £23.9bn in dividends are at risk
• £31.1bn are deemed likely to be safe

This is gob-smacking stuff. It’s been an investing truism for UK investors forever that dividends get chopped much less than share prices fall. This was even true in the financial crisis.

Indeed I’ve often argued as much in debates here on Monevator about @TA-style total return / selling capital drawdown, versus the semi-heretical natural yield approach favoured by The Greybeard and me.

My desire to live off a natural yield is often misunderstood. I’ve never argued you’ll get a higher overall return this way. It could be more or less, depending on luck and or skill.

I have also conceded every time it’s come up that you’d need a bigger retirement pot to live on if you’re not selling down your shares. You’ll leave a fat wodge when you die, too.

However for me, tithing off a steady, ideally growing income in retirement is a more palatable prospect than larking around selling assets in a bear market as a potentially shaky OAP.

True, for many years now I’ve thought such a strategy was best executed via investment trusts and ETFs rather than individual shares (such as the old HYP strategy). Good equity income investment trusts should smooth and soften the cuts, although they obviously can’t escape the underlying hit.

In addition, I’d build cash buckets and reserves into any investment income strategy.

Finally, if we do escape a deep recession and see more of that fabled V-shaped recovery, then dividends should also bounce back pronto.

But still, these cuts are a shock. It’ll be fascinating to see how this plays out in the years ahead.

Gloom aside, have a great Easter Weekend… whatever part of your home or garden you plan to be visiting! 😉

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