SUMMARY
The Fund rose 10.0%1 in April, underperforming the Small Industrials by 2.8% and underperforming the Small Ordinaries Indices by 4.3%1. For the 12 months to April, the Fund was down 17.7%1, underperforming the Small Industrials Index by 3.4%1 and underperforming the Small Ordinaries Index by 4.4%.
The strong market bounce, especially in the riskiest stocks, should not be confused as a signal that the economic challenges ahead have lowered. This bounce was driven by a phenomenal liquidity injection by the Fed. We remain conservatively positioned until clarity on the economic picture emerges, or until cyclical stocks are sold to levels which reflect despair rather than optimism. Full commentary below.
COMMENTARY
Following a global crash in March, share markets bounced rapidly in April in response to stimulus packages announced to offset the likely effect of the coronavirus. The US market rose 12.7%, which is the largest one month move in over 30 years. The Federal Reserve stepped into credit markets, buying yield instruments in unprecedented volumes. Daily purchases by the Fed were US$70bn, compared to monthly purchases in the GFC of US$120bn. This “whatever it takes” approach provided liquidity and confidence that a fully blown credit crisis was averted in the short term.
The US market finished April higher than it was in early October 2019. To think we are moving into the largest economic downturn in living history, and the market is largely flat, is somewhat perplexing.
We are pleased to show a strong return in April, however, are not surprised to have underperformed such a strong market. Such violent bounces are typically centred around the riskiest stocks, and our conservative approach will always result in a lower exposure to such investments.
This conservatism also served us well during the earlier phase of the GFC.
The potential economic outcomes over the coming 12-24 months remain highly unpredictable. Lockdown measures globally are being relaxed, which (barring further outbreaks) will result in a resurgence from the currently “frozen” economies. We do not expect this however to result in a simple V shaped economic recovery. Record job losses, business closures and bankruptcies will damage confidence for longer than the lockdowns persist.
On the flipside, interest rates are now much lower than a year ago, hence asset prices should remain reasonably well supported given the global search for income. This effect was amply demonstrated in 2019 where the US market rose 22% notwithstanding a trade war and slowing global economy.
Therefore we see scope for further volatility and poor economic data. However, companies with strong balance sheets and resilient revenues should remain well supported, while more cyclical stocks remain vulnerable. We are open to selective investments in cyclical stocks where the share prices reflect the very worst potential revenue outcomes. Right now, however, many cyclical stocks have bounced remarkably, resulting in valuations that seem to be ignoring an impending collapse in earnings. We also hold elevated levels of cash to give us the flexibility to invest in desperate capital raisings which are likely to continue in the short term.