Recession Indicator Triggered -
Discretionary Beta reduced by 25% as the market retraces 50%
As you may know, apart from only investing in rare exceptional companies which satisfy our strict investment criteria we also advocate a 3-pillar approach to capital preservation. i) Robust company selection ii) Equity vs fixed income RV (reducing equity exposure when rich to fixed income and iii) The Recession indicator.
Robust company selection
This is biased to companies which have low debt and can expand earnings in any economic climate. This is always active and reduces capital loss if we experience unforeseen event tail risk. This robustness is why in the current event we typically experienced losses of around 60-70% of the market in large down days, and finished March at -8.57% (GBP). The year to date performance to 9th April was -3.4% (GBP) after a significant (circa +5%) bounce in NAV.
Equity vs Fixed income
This is based on the richness of equity vs fixed income. With 10yr Treasury yields around 70bp this is far from being triggered.
This indicator is based on real US macro-economic data and has predicted the last 5 US recessions in a very timely manner. However, since the current situation happened without the poor decisions of economic agents rather a government enforced shut down, it has caused a unique challenge. On this occasion the indicator lagged and did not trigger until the end of March after the market move and the fed/authorities had been forced to offer unlimited support.
As outlined in my last 2 research reports (Vol as a driver of future returns, Dow30 2008 vs 2020Ytd) we think there is a very good case for long term investment. However, we thought we couldn't just ignore the recession indicator, but instead waited for a reasonable risk reduction window. It was decided that the combined target on a technical formation on the Dow and the 50% retracement of the fall, would be our target. That has just been achieved at the time of writing. Thus, we have sold short 25% of the portfolio in the form of equity index and will manage this position based on the evolution of future economic data.
By Mark Ellis, CEO Nutshell Asset Management
9th April 2020