Investing cash in the current market

When managing investments, we have to acknowledge one key truism, namely that we cannot know the future. Therefore, whenever investment decisions are made it is rarely, if ever, on certainty but on the balance of probabilities (and beware anyone that tells you otherwise!). These probabilities are ascertained by taking a series of data points and using our experience to interpret them into a range of potential outcomes, including the likelihood and magnitude of each outcome. Having done so, we make any decisions required, even if the decision is not to act, and then repeat the process as new data becomes available. Whilst the current market is exhibiting extremes of behaviour, with a number of records for the magnitude and speed of price moves being set, the process remains the same. However, in addition to the usual data points that we would use, we have an additional set of variables around Covid-19. With no precedent for the current situation, it is very difficult to know how to interpret these new data points and use them to model the various scenarios that may play out, especially in terms of timing and magnitude. Therefore, in the short-term, the whole investor universe is engaged in a huge guessing game, notwithstanding that the guesses may be considered educated guesses, depending on your viewpoint.

The saving grace is that the solution for current market conditions is very similar to any sell-off. As predicting the bottom of the market is always hard to impossible, the way that we are able to make decisions is to look a little further out, to a point when the sell-off is likely to have ended, and consider how our decisions are likely to look from that point in the future. As an example, we bought US equities in our Ruby portfolios just over 2 weeks ago after the US market had fallen 23% from the start of the year and 27% from its peak in February. At the time, the market showed no signs of having bottomed but we believed that, when we looked back in 12 months’ time, it would prove to be a good entry point, whatever happened in the short term. I am pleased to say that, along with a sterling hedge that we added to the holdings about a week later, this move has been profitable to date. However, that is not really the point, as those gains are only meaningful once we know that the market is in a longer term recovery i.e. has genuinely bottomed.

We have believed for some time that there were three points at which markets were most likely to find a floor (although there could yet be a different catalyst for the recovery to begin): when investors believe that central bank and, crucially, government responses around the world are adequate to stave off a prolonged recession; when infection rates peak in Europe and/or the US; when companies reveal their earnings figures for Q2 in July/August and investors have numbers on which to base valuations. The recovery that we have seen late last month was a product of the first of these factors, as the stimulus has been on an unprecedented scale. However, history shows us that bear markets rarely consist of a single leg down, with sharp ‘bear market rallies’ that look very much like late March common before further falls. Of course, as the cause of this falling market is unique, as is the speed at which it has occurred, it may well be different this time around. Furthermore, there has been evidence for over a week that the infection rate in Italy may have peaked and, with a number of other European countries looking like they may be reaching that point as well, we may be near the second point that would intuitively be supportive for markets. However, the US remains a concern, as the possibility that the virus has ‘broken out’ in a way that is not yet understood seems very real to us. The slow and rather dismissive initial response of the Trump administration to the virus has led to a lack of testing that makes US data hard to rely on, and whilst the US is not the only country for which that is true, it is the one that worries us the most in terms of potentially negative economic and market impact (although we have grave concerns about the human effect that the virus could have on some developing countries that have lower quality medical care than developed nations). Hopefully, the US can play ‘catch up’ and get the virus under control but, if not, a further leg down is very possible. Finally, Q3 may be the time when we know how bad the impact of the economic lockdown has been on company earnings. Clearly, should earnings be better than expected, there is the potential for the markets to rally, in which case not being invested at the point could be a lost opportunity. However, if they are worse then the reverse is true, although at least investors will have the ability to work the numbers into a full year projection, so any levels there may be a bottom from which the market can start again. Of course, this is all dependent on the lockdown being largely over, and economic activity starting to return to normal. If that has not happened, and restrictions on what would be normal behavior are still in place, the market may start to worry that the hoped for rapid recovery may not occur, and that the economic damage of Covid-19 may be deeper and longer lasting than is expected currently. In that case, we could be in for a long haul back to anywhere like previously seen market levels.

In summary, we have deployed some of our cash effectively to date but have kept more back to buy any further falls, as we cannot be certain when markets will find a bottom. Our belief is that buying at these levels is likely to prove attractive on the 12 month horizon mentioned earlier, but we could be wrong. If you have cash to deploy, you may wish to invest on that similar basis, but should accept that markets could well take a further leg down in the short term. Alternatively, if you want to ‘average in’, you could phase your cash into the market, dripping it into the market over a number of months. This would expose you less to short-term movements, but will never remove the risk entirely that the market falls just as you finish phasing in. However, investing comes with such risks and we can only seek to mitigate them, not avoid them entirely. Of course, if you wish to be cautious, you can wait until this has all passed before investing. However, you may have missed an opportunity to get in at attractive levels so, whilst it is your choice, you should understand the risk. As always, your adviser will be able to talk you through the options and advise which suit your situation best. However, they will never be able to predict which option will turn out in hindsight to have bene the most profitable, and that needs to be recognised.

Andrew Shaw, Chief Investment Officer, 2 April 2020