In these times of unprecedented volatility, I thought it appropriate to write a note to give you an understanding of our views on the current investment markets and our expectations for the outlook over the coming weeks and months.

Firstly, on the investment markets.

The current volatility is difficult to rationalise. Having managed money through every crisis from the 1987 crash to the GFC, I believe this downturn is perhaps the most difficult to justify in terms of the extent of the decline in share markets.

As the virus spreads, investors and, in fact, all market participants are extremely fearful about its ultimate impact on the global economy. We can see various market fear indices are now at all-time highs which indicates that fear and worry is very much priced into share prices.

We expect to see a big “one-off” earnings hit to companies’ earnings for this quarter. We’ll know more about the extent of this hit when US reporting season begins next month. It is worth remembering, at this point, that the value of a company is by and large based on the market’s forecasts of its earnings stream that stretches far into the future – not just one quarter. The market is stuck in the uncertainty of the eventual timing of any recovery from the virus, and how deep the fall in companies’ earnings might be in the meantime. The market appears, at this point, to be pricing the most extreme of the negative scenarios.

S&P/ ASX200 – From inception until 17 March 2020

Source: Bloomberg

With respect to the Contantgo Income Generator (ASX:CIE) portfolio, we have been active in ‘high-grading’ over the last few months –that is, selling the weaker companies in the portfolio and buying the stronger ones with robust businesses and balance sheets.

As we look through the current portfolio, we don’t foresee any major risks from balance sheet strain. We have worked hard to ensure that the companies in the portfolio have strong balance sheets and we expect this to help weather the current storm. If any of investments require funding we are in a position to participate, so we don’t expect to be diluted.

A large proportion of the CIE portfolio is defensive. An estimated 30% of the portfolio is invested in the Real Estate (REIT’s), Utilities and Infrastructure sectors. Even though the companies within these sectors have been punished almost as severely the “riskier” companies, they should hold their earnings to a much greater degree.

What do we see in the future?

We see a world where interest rates will remain low – maybe lower than where we were prior to the recent moves – and one with low growth. In this environment we expect stocks to continue to outperform other asset classes over the long-term. As such, we are focussed on investing in companies with strong balance sheets and sustainable yields and we are taking the opportunity to increase CIE’s exposure to secular growth stocks that should do well in the post-COVID-19 world.

As my colleague Peter Switzer mentioned in a recent note to SWTZ investors, feeling anxious about your losses in the stock market is understandable, but it doesn’t help. The main historical argument that will help you through this worrying period is that stock markets do rebound out of these scary times.

To quote Peter, “don’t panic. A rebound will eventually kick in.”

For us, this sell-off will represent an opportunity to invest in quality business with strong balance sheets that we will hold for many years to come.