Silverlight's Strategy for Risk Managing the CoronavirusSubmitted by Silverlight Asset Management, LLC on February 26th, 2020
It is now becoming obvious to everyone the Coronavirus will put a big strain on global commerce, and markets are quickly discounting that.
In my last post, I said stocks may be on the verge of a correction. It didn't take long to arrive. Since last Wednesday, the S&P 500 is down 7.6%.
Below is a synopsis of our current outlook, recent performance, and strategy going forward.
A spate of weak economic data is coming, which will provide fodder for perma-bears and politicians to cry foul on the economy.
The response will likely be more stimulus. Futures markets are already pricing in three more Fed rate cuts by year-end.
Short-term, it's impossible to make precise earnings or GDP estimates. But thankfully, the value of common stocks isn't based only on the next quarter or two. Equity value is based on the long-term cash generation of a company.
From purely a market perspective, we can look at the virus as similar to a non-recurring expense item for an individual company. Analysts adjust for those during earnings season, because they want to know a company's true earning power. This helps explain why markets have been resilient to past pandemic scares. They were temporary disruptions. Things eventually normalize, and markets anticipate that.
Since the market peak on February 19th, Silverlight strategies have held up better than the broad market. Below is a comparison of model portfolios (a close proxy for client accounts) to the S&P 500.
S&P 500: -7.6%
Silverlight Core Equity: -4.9%
Silverlight Core Balanced: -3.5%
Silverlight International Equity: -6.3%
Dobermans of the Dow: -6.7%
Prior to the recent selloff, we were fortunate to exit several travel-related companies, including: Royal Caribbean Cruises, Southwest Airlines and Booking Holdings.
According to JPMorgan strategist, Marko Kolanovic, there is evidence that commodity trading advisors (CTAs) were carrying heavy equity exposure, much of which they just unloaded. CTAs are part of a fast money crowd that can exacerbate price swings. CTA's equity exposure fell from the 85th percentile last week to near the 40th percentile.
The data below illustrates why "buying the dip" may continue to work, as it has throughout this bull market.
A flood of money rushing into bonds is once again producing negative real yields around the world. When that happens, investors have a choice. They can either buy bonds and lock in a decline in purchasing power, or they can buy stocks with a shareholder yield that beats inflation. The more the market falls, the greater the yield disparity tilts in equities' favor.
Since there are no major changes to our intermediate-term outlook, we are maintaining a comfortable balance of cyclical and non-cyclical positions. A "barbell approach," basically.
If the correction continues, we have room in our risk budget to be opportunistic buyers of weakness. Long-term clients know we strive to be at our best when markets are at their worst, and that remains our focus.
This material is not intended to be relied upon as a forecast, research or investment advice. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by Silverlight Asset Management LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Silverlight Asset Management LLC, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.