Vector's outlook on the Corona Crisis

23 apr. 2020

Dear shareholders,

On behalf of Vector, we would first like to express our hope that you and your loved ones will be safe, that you will be able to keep yourself relatively positive during this difficult period, and that you will still feel - albeit virtually - connected to those you love.

It will take its time, but if many the most gifted people on this planet focus their attention on this one huge problem and can work together, as is happening now on an unprecedented scale, we will eventually get this problem solved. Mankind now has one common enemy, and for once this enemy is no other nation, culture, race or ideology but something much more concrete: a virus. A virus like our ancestors had in the centuries preceding us, albeit never in such an extremely globalized world. Previous existential crises were often very difficult to solve because there was a problem of "moral hazard" hidden somewhere in it. In this crisis no one is the ultimate culprit, and so this global cooperation has not only become necessary, but also very likely.

The virus will soon start to have a hard time, because social distancing works surprisingly well, massive testing programs give hope, apps that Apple and Google and others are currently developing together are very likely to take the efficiency of virus control to an unprecedented level, drugs will improve the outcome of the disease, and eventually there may be a vaccine that offers a definitive solution, but it now looks like it will not be available to the world's population until 2021. But of course we are neither virologists nor futurologists, only economists. We will therefore not attempt to predict the virus itself or its distant future.

But as economists and stock market observers, we have to get something off our chest: the economy will not be running smoothly in the next few quarters, but rather very badly. The stock is already witnessing a V-shaped recovery, but in the real economy things are not going so V-shaped at all, rather L-shaped or U-shaped. There is an unprecedented field of tension between the stock market on the one hand (and those who think the central banks will be able to support us all), and the real economy on the other hand. The US S&P 500 lost a third of its value between its record high on 19 February and 23 March. That same stock market index has already made up for half of that loss. At the same time, a full decade of US growth in employment was reversed in one month, and last week the IMF released its gloomiest expectations since the 1930s.

So a recovery of roughly 25% has been somewhat surprising for us, as we still have no idea about the lasting impact of the virus on the real economy (and more specifically on consumption and investment confidence after several months of Corona) and about the certainty of an effective vaccine. The exponential growth in the number of unemployed makes predicting the final impact on the economy currently more art than science (just like the virus statistics themselves). By extension, of course, this also applies to businesses and sectors.

Although the monetary and fiscal response of governments worldwide has so far been spectacular, with the financial crisis of 2008 still fresh in most people’s memory, could this powerful response also avoid a major structural loss if homo sapiens were to fundamentally and globally change its behaviour? Nobody on this planet currently knows the answer to that question. A wave of defaults and bankruptcies could therefore start to eat into the stock market rebound, just like a second or third wave of the virus could, or a disastrous outcome in countries that have a less robust health system.

In fact, large parts of the world were at increasing risk of recession even before this outbreak. With prices for oil, electricity and money now below zero, this does not suggest that global demand will rapidly recover from its current low point.

Equity markets are supposed to reflect expected corporate profits, but no one can estimate future cash flows with any certainty at this time. In fact, there is relatively little point in going through the next earnings season with a comb, given that entire sectors are currently being erased.

Every crisis also produces winners, but most companies will suffer heavy to very heavy losses in this crisis. And the stock market mainly reflects the escapades of larger companies. More than half of all employees tend to work for small and medium-sized companies. SMEs will have a lot of difficulty in effectively accessing the available financial help. Central banks promise more stimulus, but after a decade of quantitative easing, its effectiveness might be rather limited.

An outright catastrophe has been avoided for the time being, but most of the emergency measures are aimed at supporting the liquidity of large companies. Growth is at least as important for the valuation of companies in the medium term, but no one can make any meaningful pronouncements about it. Consumers will only revert to their familiar patterns of consumption if they have a reliable stream of income, and if governments will not impose extreme taxes to finance this extreme stimulus.

Billions of dividends are likely to be cancelled. It might prove very difficult to reverse the earnings implosion in 2020, as a significant part of consumption is of an immediate nature, with tourism as the best example. In many advanced economies, tourism accounts for more than 10% of economic activity. Large investments are likely to be postponed, for months, perhaps several quarters.

Equity markets have so far made a positive assessment of the effectiveness of all stimulus measures. A quicker end to existing lockdowns, possibly as a result of much faster than expected vaccine development, would certainly improve our gloomy mood. But until we have that solution, confidence looks somewhat exaggerated. Therefore, we currently belong to the more cautious half of the market.

This defensive character is mainly reflected in our allocation fund, Vector Flexible, where the degree of protection is currently at a high level (68%). As a result, the fund closed the quarter with a loss of only 9.5%, which was significantly better than the world index which, at the end of March, was around one-fifth lower than at the start of the year. Vector Navigator was not spared either and posted a loss of 20.7% in Q1. As of 20/04, these figures of course look completely different. Flexible did not fully benefit from the recovery of the markets and posted a result of 3.1% in April, a little less than the 8.4% of Vector Navigator.

Best regards,

Werner, Thierry & Nils