Global markets experienced significant volatility in the wake of the Covid-19 crisis during 2020. Markets fell by 40% at their nadir towards the end of the first quarter, as restrictive measures such as social distancing and national lock-downs caused a global demand and supply shock affecting aggregate demand, trade and global GDP. Unlike the global financial crisis (GFC) in 2008-2009, this was not a systemic crisis, but the scale and speed of fiscal and monetary stimulus led by the US Federal Reserve (the Fed) to support business capacity and jobs/income drove global markets to stage a remarkable bounce, registering strong gains for the full year. Having experimented with various conventional and unconventional monetary tools with negligible inflationary pressures over the past decade, policymakers were willing to implement a response which was far greater in magnitude and speed than after the GFC. Policymakers have avoided a GFC-style liquidity crunch through the use of quantitative easing (QE), extending from government securities to corporate bonds, as well as government guaranteed lending schemes. The emerging economies have also shown a willingness to increase their fiscal spending and their budget deficit, and some have undertaken innovative policies never employed before in their history such as unconventional monetary policy with their central bank as lender of last resort to support domestic interest rates.
The path to normality will be uneven, and may include further restrictions along the way. The success of each government’s response to the virus is dependent on the strength and preparedness of public health systems, fiscal headroom and implementation of test and trace systems, as well as the successful roll-out of a vaccine across the globe. The full impact of the virus remains unclear but one can only look to the countries that are ahead of the Covid-19 recovery curve to understand the trajectory, conditional upon the above mentioned factors. Much of North Asia as well as parts of South East Asia have dealt with the crisis much more efficiently due to their past experience of handling pandemics, as have Australia and New Zealand.
As observed, few industries and sectors across the globe were completely insulated from the spread of the virus. Some industries have been more negatively impacted than others especially in hospitality, leisure as well as bricks-and-mortar retail, particularly given that more flexible working structures have damaged ecosystems reliant on commuting and office working.
We believe monetary policy is likely to remain accommodative for a prolonged period until the Fed is assured of a sustained economic recovery with full employment (as per its dual mandate) and to ensure that rising indebtedness across the government, corporates and households does not pose a long term burden on their respective finances as a result of higher debt servicing costs. Central banks elsewhere are likely to follow the lead of the US with a move towards “average inflation” targeting in an effort to keep real interest rates negative and spur economic recovery. Within the tool kit available to the Fed are “yield curve control” as well as negative interest rate policies adopted by other regimes, notably by the Bank of Japan and the European Central Bank respectively, so as to ensure liquidity and lower long term borrowing costs to induce investment and employment. Of particular note are geographies with fiscal headroom that are more capable of pursuing counter cyclical spending to spur growth making them less reliant on the need for interest rates to go below zero reducing the negative implication on their currency. We believe that investment is likely to be along two themes: i) productivity improvement through technology such as the adoption of automation across both manufacturing and service based sectors; and ii) localization of supply chains to ensure self-sufficiency, notably in technology, healthcare and food sectors.
Coordinated monetary and fiscal policies will continue to support widening budget deficits, leading Debt-to- GDP ratios to likely exceed 120% for both the US and the eurozone. Concerns over rising bond yields may be quelled by the use of “yield curve control” as is currently in use in Japan. Nonetheless, this cycle of higher debt, lower interest rates and lower real bond yields could make it difficult for central banks to eventually normalize monetary policy when the recovery does arise as we have observed during the last decade.
Prolonged accommodative financial and liquidity conditions following the GFC have resulted in slow progress in deleveraging and lax implementation of structural reforms to improve productivity. Asset price inflation caused by these accommodative conditions, in addition to lackluster real economic growth, have led to wealth inequalities which, coupled with inadequate social safety nets to cater for those disadvantaged by globalization and automation, have created social issues with implications to politics, stability and growth. Unless these issues are resolved, and without significant improvements in productivity and structural reforms, we believe developed economies will face a path of lower trend growth, modest inflation and lower short-term policy rates relative to history. This will continue to drive the search for yield and investments providing growth, favoring investment in inefficient asset classes such as developed and emerging small cap which further offer structural growth prospects.
Despite running “twin deficits” (fiscal and current account) for many years, the US dollar’s unique position as reserve currency coupled with its safe haven status as well as stronger relative economic growth has ensured that the currency has displayed strength, while the US equity market has been one of the best performing markets since the GFC. Valuations are rich and a strong US dollar limits further upside. As a result the investment case for international equities – both developed and emerging small cap – is compelling to a US-based investor thanks to their attractive valuations coupled with the overvaluation of the US dollar against most currencies. Further the small cap asset class, with its large universe of relatively under-researched and often mispriced stocks, creates alpha generation potential which can be unlocked through active management. Market uncertainties with tail risks present opportunities for a manager like Mondrian which adopts a disciplined investment approach focused on target real rates of return, downside protection and minimized volatility.
The Mondrian International Small Cap equity portfolio adopts a diversified and balanced approach capturing attractively valued investments with well capitalized balance sheets, enjoying structural growth opportunities with sustainable business models and strong cash flows to support growth and progressive dividend payments. This strategy aims to deliver both downside protection during periods of volatility as well as upside capture during periods of optimism. The strategy has remained consistent since the end of 2015, with a focus on increasing exposure to fiscally strong economies, and this will continue given their ability to support a post Covid-19 recovery.
Views expressed were current as of the date indicated, are subject to change, and may not reflect current views. All information is subject to change without notice. Views should not be considered a recommendation to buy, hold or sell any investment and should not be relied on as research or advice.
This document may include forward-looking statements. All statements other than statements of historical facts are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results to differ materially from those reflected in such forward-looking statements.
This material is for informational purposes only and is not an offer or solicitation with respect to any securities. Any offer of securities can only be made by written offering materials, which are available solely upon request, on an exclusively private basis and only to qualified financially sophisticated investors.
The information was obtained from sources we believe to be reliable, but its accuracy is not guaranteed and it may be incomplete or condensed. It should not be assumed that investments made in the future will be profitable or will equal the performance of any security referenced in this paper. Past performance is not a guarantee of future results. An investment involves the risk of loss. The investment return and value of investments will fluctuate.
