The spread of the Coronavirus and the acceleration of cases outside China last weekend has been the catalyst to a swift market correction. There is still significant uncertainty over how the virus will continue to spread, which has certainly added to the speed and magnitude of the sharp correction we’ve witnessed.
Efforts to slow the virus’ spread have resulted in mass quarantines which will undoubtedly be a headwind to global economic growth. We have already heard from numerous businesses that sell directly into China or have significant supply chain exposure that are feeling the slow down. The economic impact will surely be felt and as this correction has occurred, the impact has been broad with travel-related industries and economically sensitive businesses seeing the largest impact. Cyclically exposed businesses like industrials, energy or pockets of consumer, or technology firms with significant supply chain exposure to China are among those industries. Our positioning into the year was pro-cyclical with high industrial and energy weights. We did not forecast a pandemic; however, we have reduced cyclical positions through January and into February. Even so, we maintained exposure to the cyclical areas of the market, which impacted performance over this short and volatile timeframe.
It is important to remember that we should expect volatility as part of investing and market corrections occur with some regularity. While near-term disruptions are unavoidable, the wide-spread uncertainty and indiscriminate selling has provided attractive opportunities for investors with longer term time horizons. At times of heightened market volatility like this, we focus on what we can control and lean on our investment process to guide our decision making. Although we didn’t see this coming and don’t know how this pandemic will continue to spread, a key focus of our investment process is understanding a range of potential scenarios - both positive and importantly negative - and the resulting impact on the financial profile of a business.
Through this sell-off, like those in past years, we are looking to ‘high-grade’ our exposures where we can as we evaluate and reposition our clients’ portfolios to improve the overall risk/reward. With an uncertain path ahead, we are focusing our efforts on business models we’ve identified as the highest quality with clean balance sheets. These businesses are well positioned to weather the storm of economic disruption and become stronger through challenging environments by gaining share within their respective industries.
Although these market dislocations can be challenging for clients, we are actively monitoring our coverage list of business and repositioning to where we see the best risk/reward prospects going forward.
Geoff Scott, Institutional Portfolio Manager
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Published March 2, 2020