How To Think Through Market and Fundamental Uncertainty

Brandon Snow, Principal and Chief Investment Officer

We have had unprecedented moves in many markets over the last few weeks, and it’s important to remember unprecedented things happen in the market over and over again. While this situation is unique, the market behavior is not unusual.

While we don’t have a lot of certainty about what will happen from here, we wanted to share our framework for thinking about these situations. It has helped us react since the very beginning at Cambridge, especially over the last month, and think this will help guide our decision-making from here. While we can’t change what has happened, we can take in all available information and make the best decisions we can today in this period of uncertainty.

As investors we have two points to consider: (1) What the market is thinking/reflecting and (2) What is happening to fundamentals. In both cases, there are things we know and things we don’t. Here is a snapshot of the matrix we have been using to think through this with some points (not an exhaustive list):

Market Reality
What we know
  • Treasury market is very illiquid; bid-ask spread has blown out
  • Credit is under stress (OPEC + other)
  • Equity players have derisked
  • We are seeing panic in markets
  • Travel demand has collapsed
  • Energy demand has collapsed, supply is ramping
  • Companies are drawing on credit lines due to economic uncertainty
  • COVID-19 cases likely continue to climb in North America, following the patterns we have seen in Asia and Europe
  • China has been recovering towards normal
What we don't know
  • How much of the treasury market malfunction is technical (poor positioning by levered funds) vs. fundamental
  • How long dislocations will last
  • What can central banks do to stop the panic
  • What they will do
  • The ultimate response by companies and governments
  • The ultimate economic impact
  • The ultimate infection and deaths caused by COVID-19
  • The ultimate level of hysteria around the virus risks
  • How long will Saudi Arabia and Russia continue to oversupply the oil market
  • What will the bond market dislocations do to the availability of funding for companies
  • Could this burst the private equity bubble

As you can see, we have had significant derisking in financial markets and alarming malfunctioning of liquid and safe securities. From the ‘reality’ perspective, there still remains significant uncertainty about the impact of the virus (and credit stress it is contributing to) on economic activity, although the rebound we are seeing in China is encouraging.

Using this framework, we had reduced cyclical/credit exposure ahead of the recent decline in the market leaving Cambridge Canadian Equity Fund with 15% cash entering this week (week of March 9). The source of funds were commodities, cyclicals and credit exposed firms. Today, with equity markets down 25-30% from their highs, we are starting to see some attractive absolute valuations and are beginning to deploy capital. However, it is important to remain mindful of the risks surrounding the credit and treasury markets so the focus is on high quality business models with strong balance sheets, including some business at the epicenter of these shocks. After today, we will still have enough dry powder to deploy as the situation continues to evolve.

There remains tremendous uncertainty, but we do feel comfortable that with the appropriate framework for decision making we will navigate well from here.

Before we conclude, we want to repeat what we said at the beginning of this blog: we are seeing a lot of unprecedented things happening in the market and the world and that is not unusual. We must assess the situation as it evolves and make the best decisions we possibly can.

Source: Cambridge Global Asset Management

Thank you for your continued support.

Brandon Snow signature

Brandon Snow, Principal and Chief Investment Officer

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Published March 13, 2020.