Resilient outcomes

Why defence still makes sense

Even before the pandemic hit, the backdrop for financial markets and economies was unstable. It is considerably less predictable. Whether you are optimistic or not, we believe this increasingly unstable world is why defence still makes sense.

8 Sept 2020

7 minutes

Even before the pandemic hit, the backdrop for financial markets and economies was unstable. It is considerably less predictable. Whether you are optimistic or not, we believe this increasingly unstable world is why defence still makes sense.

The fast view

  • Last year, we wrote about why defence makes sense even when markets continued to reach new heights. Then the pandemic hit, bringing with it the fastest, sharpest drawdown yet seen.
  • One year on, we’re making the same case based on the same underlying concerns we’ve had about the changing structure of markets since 2008.
  • We explain these changes, their causes and their consequences, in this piece. Namely, that we believe investors should continue to expect more frequent and larger drawdowns in future.
  • An inherently unstable world, yes, but we think it’s the one we’ve been living in since 2008. It’s why we designed a defensive strategy to navigate less stable market conditions and why we believe – whether you are optimistic or not – defence still makes sense.

Introduction

Even before the pandemic, the backdrop for markets and economies was unstable. It is considerably less predictable now. While the dramatic collapse in asset prices in March 2020 was unique, we think investors should expect more and larger drawdowns than prior to 2008.

‘Secular stagnation’

‘Secular stagnation’ was first coined by the economist Alvin Hansen in 1938. Back then, the US economy was struggling to escape from the Great Depression. Hansen suggested that slowdowns in population growth and technological advancement were suppressing both investment and consumer spending. This, he believed, would stop the US economy achieving full employment indefinitely. Hansen’s pessimistic thesis turned out to be wrong, but only perhaps because of the outbreak of the Second World War.

Larry Summers, another prominent US economist, resurrected Hansen’s theory in 2013. He believes that again we live in a world of insufficient demand, where people are saving too much. Deficient demand makes it difficult for an economy to grow at capacity, and excessive savings mean that it requires very low real interest rates to stimulate demand. Together, these effects make it hard to achieve adequate growth, full employment and financial stability simultaneously.

The forces potentially contributing to a lack of demand and excess savings are well established. They include: aging populations, excessive debt, rising income inequality and technological change.

Paradox of thrift

According to Summers, “Secular stagnation occurs when neutral real interest rates that balance saving and investment at full employment are sufficiently low that they cannot be achieved through conventional central bank policies. At that point, desired levels of saving exceed desired levels of investment, leading to shortfalls in demand and stunted growth”.

Since the global financial crisis (GFC), it has become increasingly hard to argue against this thesis. Ever-looser policy has failed to deliver consistently stronger growth or higher inflation.

Inflation has undershot expectations since the GFC

Inflation has undershot expectations since the GFC

Source: Ninety One, Bloomberg, Citibank Inflation Surprise Indices, June 2020.

The inevitable side effect, Summers says, is that “sustained low rates tend to promote excess leverage, risk taking and asset bubbles.” In other words, the world of secular stagnation is inherently unstable, with the forces which are undermining growth requiring ever-looser policy to offset them, resulting in economic and financial market stress and sharp episodes of volatility.

Worsening liquidity

Since the GFC, other factors have tended to reinforce market instability. In August 2019, Bloomberg reported that, since 2007, average daily turnover in US Treasury bonds had fallen by over 60%, with a similar drop in trading in the corporate bond market. Large declines were also observed in the equity and futures markets. According to Bloomberg, other indicators of worsening liquidity included 'significant intra-day moves, frequent price spikes, higher volatility of bid-offer spreads and the proliferation of flash crashes such as the sharp increase in the Cboe Volatility Index, or ‘VIX’, at the end of 2018 and the Japanese yen flash in January 2019'.

These trends likely reflect changes in market structure over time, such as the diminished capacity of banks to use capital to support market-making, as well as the growing influence of algorithmic trading and the rise of passive investing. Whatever the causes, the implication is that scarce liquidity can be expected to exaggerate market moves in the future, particularly to the downside.

Evidence of instability

As well as the increased preponderance of sharp market swings highlighted above, there are other signs of increased asset-price instability. For example, the equity bull market following the GFC has been far messier, especially in terms of drawdowns, than the one that proceeded it, with many more large falls in price over the past decade than before the crisis.

More extreme drawdowns in MSCI ACWI since the GFC

More extreme drawdowns in MSCI ACWI since the GFC

Source: Ninety One, MSCI data, July 2020.

With poor market liquidity and an even more extreme imbalance between the range of negative impacts on growth and the extraordinary policy adopted by central banks to support economies in the aftermath of the COVID outbreak, investors will likely need to be even more focused on finding ways to live with skittish and vulnerable asset prices.

This supports the case, we believe, even in those periods when risks appear to have diminished, for allocating a portion of portfolio exposure to defensive strategies designed to navigate less stable market conditions – whether you are optimistic or not, in a world that appears inherently unstable, defence still makes sense

Authored by

John Stopford

Co-portfolio manager

Jason Borbora-Sheen

Co-portfolio manager

Important Information

This information may discuss general market activity or industry trends and is not intended to be relied upon as a forecast, research or investment advice. The economic and market views presented herein reflect Ninety One judgment as at the date shown and are subject to change without notice. There is no guarantee that views and opinions expressed will be correct, and Ninety One’s intentions to buy or sell particular securities in the future may change. The investment views, analysis and market opinions expressed may not reflect those of Ninety One as a whole, and different views may be expressed based on different investment objectives. Ninety One has prepared this communication based on internally developed data, public and third party sources. Although we believe the information obtained from public and third party sources to be reliable, we have not independently verified it, and we cannot guarantee its accuracy or completeness. Ninety One’s internal data may not be audited.

Investment involves risks. Past performance is not indicative of future performance. Any decision to invest in strategies described herein should be made after reviewing the offering document and conducting such investigation as an investor deems necessary and consulting its own legal, accounting and tax advisors in order to make an independent determination of suitability and consequences of such an investment. This material does not purport to be a complete summary of all the risks associated with this Strategy. Ninety One does not provide legal or tax advice. Prospective investors should consult their tax advisors before making tax-related investment decisions.

In Hong Kong, this communication is issued by Ninety One Hong Kong Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong (SFC). The Company’s website has not been reviewed by the SFC.

Except as otherwise authorised, this information may not be shown, copied, transmitted, or otherwise given to any third party without Ninety One’s prior written consent. © 2021 Ninety One. All rights reserved. Issued by Ninety One.

Past performance figures shown are not indicative of future performance. Investors are reminded that investment involves risk. Investors should refer to the offering documents for details, including risk factors. This website has not been reviewed by the SFC. 

By clicking on the hyperlink of Investor relations below, you are leaving this website with information specific for retail investors in Hong Kong and entering the global website.

Please note that the global website is not intended to target Hong Kong investors. It has not been reviewed by the Hong Kong Securities and Futures Commission (“SFC”). The website may contain information on funds and other investments products that are not authorised by the SFC and therefore are not available to retail investors in Hong Kong. The website may also contain information on investment services / strategies that are purported to be carried out by a Ninety One group company outside of Hong Kong.

Any product documents and information contained in this website are for reference only and for those persons or entities in any jurisdictions or country where the information and use thereof is not contrary to local law or regulation.

Issuer: Ninety One Hong Kong Limited
Email: [email protected] 
Telephone: (852) 2861 6888 
Fax: (852) 2861 6861