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COVID-19 and the undifferentiated sellout

Reading time 10 minutes

February could hardly have been more contrary. From new record highs on the stock markets to sheer panic and the flight to safe havens, it only took the blink of an eye. The fragility of the markets, which has been mentioned repeatedly at this point, materialised in the last few days of the month in heavy price losses.

But first things first: During the first three weeks of February, everything looked like a continuation of the extremely strong 4th quarter of 2019 in terms of performance: Volatility at a low level, prices at an airy height, and investor optimism unchecked. As expected, our risk-based equity and bond strategies were unable to keep up with the respective market indices during this phase and lagged significantly behind (the figure below illustrates this using the February performance of our OLZ Equity World Optimized ESG).

Suddenly, the Western world realized that COVID-19 will spread from a regional crisis to a global pandemic. This change in perception created massive shock waves in an already very critical environment for the economy and financial markets:

  • In 2019, the global economy recorded its weakest growth since the financial crisis of 2008 - especially in the fourth quarter: the manufacturing sector shrank considerably, GDP growth was negative in Japan and in China it was the lowest in 27 years.
  • Numerous stock indices reached new historic highs by mid-February. These market advances were mainly based on the anticipation of a strong economic recovery in the first half of 2020.
  • When SARS broke out in 2003, China's economic output accounted for around 8% of global GDP. This share has since risen to 20%. This is a cause for concern, as China is now facing a significant slowdown in economic growth.
  • Average earnings growth in 2020/21 was expected to be in double digits - a forecast that will most likely be significantly revised downwards.

Against this background, what could be called an undifferentiated sellout followed.

But why "undifferentiated"? Let us compare the price setback we have just experienced with the 4th quarter of 2018 (at that time, the markets were trembling with a more restrictive monetary policy). The magnitude of the market correction (here using the example of the MSCI World), accompanied by a sharp rise in volatility, was of comparable magnitude in both events. Looking at the performance of the individual sectors, a completely different picture emerges. While Q4 2018 saw a clear rotation from cyclical to defensive sectors, in recent days everything has been thrown onto the market, regardless of sector affiliation. This behaviour suggests that the February interlude has not yet included an adjustment of the high earnings expectations in the sectors that had grown the most in recent months (e.g. IT, communication services or consumer discretionary).

Now the obvious question arises as to how OLZ strategies have performed during the market correction. In general, our equity funds were able to stem the losses compared to the benchmarks and the bond strategies with a focus on high-quality government and corporate bonds were able to gain. The diversification principle at the portfolio level therefore proved itself once again. Over the month as a whole, our equity funds did not achieve a significant outperformance or even performed marginally worse than the respective benchmark. The performance analysis shows that our equity strategies were not quite as successful in cushioning the market slump as they were in Q4 2018, for example, due to the undifferentiated sell-off described above. Although risk-conscious stock selection added value, the indiscriminate selling of cyclical and defensive stocks caused our outperformance to be lower than the market average. However, when this global epidemic affects earnings growth, cyclical stocks will be hit hardest. Our more defensive sector allocation will then again help to reduce any further losses.

For the coming weeks and months, we remain confident that the cornerstones of our investment strategy, diversification and risk management, will deliver a clear benefit in weathering this uncertain and critical market phase.

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