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What in the world?

U-WEN KOK, CFA 07-Apr-2020

When bustling international cities become ghost-towns during rush hour, it’s easy to understand why global stocks have been unmercifully punished over the last few weeks. The Covid-19 outbreak has canceled conferences, banned travel, and squelched demand. Borders have closed and supply chains everywhere have been disrupted. 


Acknowledging that the global economy has grinded to a near stop, governments and central banks around the world—including the Federal Reserve, Bank of England, Bank of Japan, European Central Bank, People's Republic of China, are stepping in with synchronized emergency responses in the form of monetary or fiscal stimulus. It remains to be seen how these efforts to boost liquidity and confidence play out. The bottom line is that investors are concerned about earnings risk. We are closely watching the earnings of global companies as well, and we fully expect that markets will continue to be volatile. 


After examining the MSCI factor style indices, we found one thing puzzling. Stocks with overall strong quality characteristics underperformed those with positive momentum on a relative basis, through the middle of March 2020. This seems counter-intuitive to us as we would expect investors would gravitate toward quality names in times like this. 


Digging deeper, we studied the performance of our proprietary model during two other pandemics to see if we could draw any specific conclusions. In both instances, the market environments were very different going into the outbreaks, and perhaps that’s what accounted for different findings. In 2002-03 (the SARS pandemic), the economy was fragile and going through a “jobless” recovery, and investors were worried about the Iraq war. In contrast, during 2012-13 (the MERS pandemic), the economy was stronger and recovering robustly five years after the Global Financial Crisis. In each period, the quality, value, and sentiment factors that we follow closely behaved quite differently. 


So while we cannot definitively say that “quality” performs better in pandemics per se, we still confidently offer the following thoughts regarding the current state of global equity investing: 


  1. A focus on quality, profitable companies that consequently have deeper pockets and better balance sheets should be better equipped to weather periods such as this. 
  2. Risk protocols are paramount in these times, and any global investing strategy would be prudent to have a process committed to remaining benchmark-neutral with regard to regional and sector diversification.
  3. Be wary of global managers touting allocation calls and, subsequently, not exposed to all sectors or all regions within the global benchmark. This amps up the risk of that strategy even if it may have benefited performance in the short-term.

Remember, even in the most challenging environments there will be companies positioned to succeed, and an active global manager should be able to identify them. Having the discipline to stick with a vetted, quality-oriented bias might prove to be the best approach for global equities, especially in times like this.