Weekly update: the safest place to be in a crisis

This week we are spending some time trying to learn the lessons that last month’s surge in financial market volatility has taught us. While it is still early days in the potential market recovery, we believe that this “once in a lifetime event” can still teach us useful lessons about how markets react when investors are in a panic and how they will behave during the recovery period. 

As you will see, Minerva has added in a new addition to her analysis this week, a chart! We are experimenting at this stage, but if you think that it is useful to you, then please let us know and we will be sure to add more. On that drumroll, the chart that we are looking at today contains the Swiss Market Index (SMI) and the UK’s FTSE 100. This chart has been normalised to show how the two indices have been moving together. As you can see, the Swiss index has outperformed the UK index for the past year, which is understandable since the UK index had been a global under-performer before the coronavirus crisis due to continued Brexit risks. However, the plunge in equity indices caused by Covid-19 was noticeably deeper for the FTSE 100 (and other European indices), than it was for the Swiss equity market index. The Swiss market fell approx. 10% peak to trough, compared to more than 40% for the FTSE 100.  On an annual basis, the SMI remains in positive territory, and is up 2.1% year-on-year, compared with a 20% decline YoY for the FTSE 100. 

This information is important. In times of unprecedented market panic, like we saw in the first few weeks of March, the trading community treated the Swiss equity market like a safe haven as much as they did the Swiss currency. Thus, when we think about a defensive portfolio of stocks, one that can withstand a deep market fall, we normally talk about sectors, such as utilities, consumer necessities etc. However, the overall outperformance of the SMI relative to the FTSE 100 suggests that we should also look geographically to try and make our stock portfolios as defensive as possible. Other countries with a safe haven currency, like Japan, also saw their stock market outperform other global indices, for example the annual decline in the Nikkei is approx. 10%, half the decline in the FTSE 100. However, the SMI stands out, even when compared to its safe haven peers. 

The reason why the SMI may have been more protected than the Nikkei during the coronavirus sell off is likely to be down to two things: 1, the relatively small size of the index, and its limited  exposure to globalisation, companies that require complex global supply chains to operate have been particularly badly hurt during the Covid-19 market sell off, and 2, the large number of health care and pharma companies in the SMI, which have outperformed during the pandemic.

So, in case we encounter another event that is caused by a virus and leads to a global lockdown, then don’t forget about the often overlooked SMI. However, that advice, at this stage, isn’t that useful. The question now is, where will the SMI and the FTSE 100 go next? We believe that in a prolonged recovery the FTSE 100 could outperform the SMI index and the chart below could see the orange line cross above the white line if risky assets engage in a sustained recovery rally. This is all down to two things: 1, relative valuations and 2, the FTSE 100’s exposure to globalisation. Regarding relative valuations, the FTSE 100’S price to earnings ratio is approx. 16, that compares with nearly 20 for the SMI index. Of course, earnings prospects are likely to be hobbled for the FTSE 100 for the next few quarters, however, if investors have a long time horizon, then the FTSE 100 looks fairly good value right now. Secondly, the FTSE 100 has been punished in recent weeks because of its exposure to globalisation and to the energy market. If investors start to price in a recovery for large global companies and for global trade then the FTSE 100 should lead the way. Likewise, if Opec agree to an oil production cut and the G20 group of oil ministers, meeting later this week, find a way to heal the rift between Russia and Saudi Arabia, then we may see the oil price bounce, which is also good news for the large oil companies in the FTSE 100. 

To conclude, the SMI is a good equity index to hold when the going gets tough, however, when the days ahead start to look brighter it may be wise to switch to the FTSE 100. 

Chart 1: The SMI (white line) and the FTSE 100 (orange line) , source: Bloomberg