What to write when the world has ended?

Let’s be honest, the novelty is starting to wear off.

At home, and in the markets.

At home, we’ve branched out into some of Ottolenghi’s wilder recipes, done an in-house blind wine-tasting and quiz, and ordered ourselves some new books and PlayStation games. I’ve broken my 10k run record, spent some quality time with flatmates and really embraced the peaceful nature of the quarantine. I won’t lie to you, it’s been a lovely couple of weeks.

All the while, the markets have raged.

The novelty of quarantine led to an uptick in excitement, as we devised indoor games like table squash, pushed ourselves in the kitchen and around the parks, and discovered a few great new tv shows (Ragnarok on Netflix, The Test on Amazon Prime).

Meanwhile, the novelty of coronavirus led to market swings on a genuinely unprecedented level – volatility was higher than ever before in markets:

Source: J. Brett Freeze, CFA on Twitter

Today though… meh.

At home, we’re putting in an Amazon order for new books, new games, and trying to write a list of things to do, cook, bake, target or whatever.

In the markets, indices are down a bit, not a lot. American futures are basically flat.

It feels like the new normal has arrived.

Governments everywhere are warning of 3-6 months lock-ins, restrictions and no normal service for up to a year.

China seems to be getting into gear again – it’ll be interesting to see how that goes.

I feel like that guy in a race who sets off way too fast. And suddenly, we’re all realising that current levels of excitement at home, or panic in the markets, can’t go on for months.

To illustrate this idea, take a look at this chart of the CBOE’s VIX index, which measures implied volatility (the chart above shows what actual volatility has been, the VIX uses options to show what the markets think it will be.) This time around, it topped 2008 levels, suggesting that the markets are slightly more pessimistic than me, as per my article on Friday.

Source: CBOE

Here is the VIX index again, but close up (one-year time frame).

Source: CBOE

Trees don’t go to the sky.

The week which saw multiple double-digit moves in markets across the globe was obviously the peak, but the thing is it should have been the peak of realised volatility, not implied volatility.

At that point, investors should have started thinking – this is crazy, volatility is so high, it’s much more likely to fall than rise now.

Contrarianism (famously the most popular investment strategy) is going long volatility (betting it’ll go up) in January when it’s languishing at 12, and shorting it (betting it’ll go down) when it’s in the 70s and 80s.

It is overwhelmingly unlikely that volatility will stay at record levels for a period of months or years. Take a look again at the first long-term VIX chart, and in particular at 2008.

You don’t need to call a top or a bottom. Only excess or distress.

Take bonds, for example.

This is what happens to a 60/40 bond portfolio over a period of decades, if you don’t rebalance (top up bonds and sell equities when the 60/40 ratio dwindles). That’s because over time, equities outperform bonds. Bonds are great in years like 2008 and 2020, but otherwise equities dominate for a host of reasons (reinvestment, compounding, inflation, economic growth…).

Source: The Irrelevant Investor

For me, as an equity advocate, this tells me that bonds are helpful as insurance against the first crisis of your investing lifetime, and so are not totally useless, but that anyone with an investment horizon beyond a decade shouldn’t be interested in them at all. But I am biased on that front.

But the point is, at points in the last month, choosing government bonds over stocks meant you thought that the 1% guaranteed maximum return on your bonds (ignoring the negative result from buying bonds well above par value), was a better move than buying the stockmarket.

My point about volatility applies to bonds too.

Just as everyone was screaming buy stocks in 2019, and declaring that “cash is dead”, everyone was screaming to buy bonds a week or two ago.

But screamers don’t make good investors.

Level-headed long-term thinkers do, and buying bonds in the last two weeks is probably a bad move if you’re looking anywhere beyond a few months, or if things don’t deteriorate significantly again soon.

Today, I’m seeing a lot of similar chatter about oil.

It’s fallen 2/3 in price. There are oil majors trading at multi-decade lows, some midstream companies trading at P/E ratios below 3, with historic dividend yields above 50%.

Predictions abound of $10 oil, $0 oil or even negative oil prices.

This feels like the same thing all over again. Just as things are getting to their worst point, a bunch of people have caught up and taken their previous straight-line extrapolations (up, up, up and awaaaay), and flipped them (how, low, can you go!).

The night is darkest just before the dawn.

Be greedy while others are fearful.

Markets don’t bottom when the sun shines once more. They bottom while the night is still black, just a shade less black than the day before.

In the same way that the majority of people didn’t predict coronavirus, or the cartel-induced oil crash to $20, very few people can say with confidence what will provide support to the oil markets.

For example, the Saudis are ravaging their own economy and may feel they’ve made their point. The US is calling on OPEC to reconsider, and it may feel that humbling the US in this way counts as achieving its goals. It may feel able to get a better deal now.

And it doesn’t need a resolution, just a hint of action or intention to remind people that things can get better again. Supply excess may fade, demand will return…

While the arguments for lower oil are much more convincing and based on sound reasoning and plenty of evidence, the things they warn of are to a large extent pre-feared.

My eternally wise brother always told me, don’t worry about things twice.

What he meant was – don’t worry about whether something might happen, cause you’re going to worry if it actually does come.

So, get on with it for now, and if it does come about, that’s your cue to worry.

Investors don’t follow this rule though. In fact, it’s their job not to. So, the question you have to ask is, all these reasonable arguments for lower oil… aren’t they the reason why markets are already lower?

And the same applies to the virus. I think it might take a significant new development to shake markets to the panicked levels of volatility seen last week.

Investors have spent a fortnight having nightmares. Worst-case scenarios have been dreamt up, and acted up. Not totally, but to an extent.

For things to significantly deteriorate from here, new concerns must appear. I’m not saying they won’t, only that we’ve had our oil shock, and we’ve had our virus shock.

When people were parading around in Dow 30K caps, it was a sign to be cautious.

With people writing NEGATIVE OIL into hysterical articles, perhaps the opposite is true.

If you want to worry about something, worry about what comes next. If you’re panicking about negative oil and the virus, you’re behind the curve.

If you want to worry about something, try inflation, corporate bond defaults, emerging markets or the integrity of fiat currencies.

And to avoid finishing on that bleak note, how about a couple of great things that hit my inbox from Nick Hubble this morning.

The first is a chart showing that total US weekly deaths from all causes is far lower than normal. Coronavirus is actually saving lives for the time being (fewer car accidents, alcohol-induced deaths, etc).

Source: David Weekly on Twitter

And how about this rib-tickler from down under: astrophysicist gets magnets stuck up nose while inventing coronavirus device.

All the best for now,

Kit Winder
Investment Research Analyst, UK Uncensored

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