The mood on global financial markets has changed at lightning speed in just a few weeks. From a hunky-dory sentiment and record high prices on most assets in late February to a complete turmoil, falling prices on stocks, credit bonds, commodities and record low bond yields and huge intra-day volatility in early March.
This change of mood is caused by the negative effects on the global economy due to the outbreak of the coronavirus combined with very bullish and growth-optimistic investor sentiment until mid-February, and very high valuation of most assets. On top of that an "oil-war” between Saudi Arabia and Russia broke out at the weekend, leading to plunging oil prices.
Thus, asset managers in the liquid space of stock, bonds, commodities and foreign exchange have a very busy few days trying hour by hour to gauge whether to buy cheap or just run and hide.
Meanwhile, asset managers in the illiquid alternative investment space sit a little more calmly in their offices and observe the global market fuss, as their investments do not come with a daily price tag.
However, they can’t be too laid back, as the market turmoil has already revealed some weak spots and some areas where prudent managers of alternatives will need to take a closer look at their investments soon, no matter whether we’re heading for a recession and deeper downturn, or this is just short term noise and volatility.
Investors in the alternative investment space have thus been given a forewarning by the market turmoil. Either the warnings will be of relevance very soon, if we enter a recession, or will come back during a future economic downturn.
Here are some of the market signals to watch out for as an alternatives asset manager:
Firstly, one of most interesting cracks in the market is in Southern Europe. Here, periphery euro bonds are massively underperforming compared to bunds and northern European bonds.
While yields on bunds or Danish, Finnish or Swedish government bonds, for example, are plunging to new record lows, yields on bonds from Italy, Spain, Portugal or Greece are rising.
This is a clear signal that investors, in case of an economic downturn, still see a great danger of a renewed euro crisis or turmoil.
Thus, a euro-break-up scenario is very relevant to take into consideration, especially when stress-testing the resiliency of alternative investment portfolios versus a future economic downturn.
The risk for a Nordic investor of owing a wind turbine farm, a highway or a parking lot in Italy is not the same as owing the same type of investments located in the Netherlands, Germany or Finland despite them all being in Europe. Country risks have to be taken into consideration.
Secondly, when the going gets really tough in financial markets, gold is not always a good hedge, even in a deflationary scenario of plunging real bond yields.
That was obvious during some of the worst months during the global financial crisis (GFC) back in 2008/09 and it became obvious again during the first week of severe turmoil in late February.
While global stock prices nose-dived 12 percent, gold prices dropped 5 percent and only high quality long bonds provided true downside protection.
However, gold rose again strongly in the last months of the GFC and also rose strongly last week in reaction to monetary easing from central banks around the world, not least the surprise 50 bps. cut by the Fed.
The question then becomes: What if central bank rates are at zero or below when the next recession hits and monetary policy has lost its final power? How would gold perform then?
My own guess is that gold would provide some protection, especially if investors start to question the sustainability of ballooning government deficits and see default risks rising. That conclusion seems to be supported by yesterday’s market action, where gold prices were steady, while stock prices and bond yields plunged further.
Thirdly, several infrastructure heavy stocks have taken a serious beating in the last couple of weeks, suggesting that prices of some of the more cyclical infrastructure assets are particularly vulnerable.
Take French company Vinci, a big player within concessions of motorways, airports and other infrastructure activities. Its stock price has plunged 25 percent in just a couple of weeks, signaling that investors see a very high risk of cyclicality in its business model.
That merchant infrastructure investments can be cyclical should come as no surprise, but the severity of the downturn is.
Finally, oil prices have plunged 50 percent within just two months . First as a reaction to lower demand in the wake of coronavirus and its effect on the world economy, and in the last couple of days, as a reaction to the ”oil war” between Saudi Arabia and Russia.
Therefore, it has suddenly become very relevant for investors in alternative investments to stress test the value of their investments, especially their green investments, at a much lower oil price.