Finding Growth in a Bear Market

 Matthew Small, Portfolio Manager

The economy is on the cusp of recession, being battered by high inflation, rising interest rates, low economic growth, a cost-of-living crisis and geopolitical instability. The markets as a result have suffered with the S&P 500 realising the worst H1 in 40 years and flight to safety asset classes like treasury bonds and gold prices struggling to find momentum next to a strong dollar and higher interest rates.

With most traditional portfolios “diversified” between equities, bonds and real estate all struggling, cash is no longer king with 9% inflation and rising, investors are seeking alternative investments to weather the current financial storm.

 

What’s the alternative?

Analysts predict 46% growth in the Alternative Asset market over the next 12 months, driven by investors’ need for diversification and inflationary hedges. We expect wine to lead the way within the Alternative sector due to its stable returns and low price volatility. Wine is the only Alternative listed as both a financial and consumable asset, making it best seated to deal with inflationary spikes. The UK market currently lags behind its European neighbours with only 35% of UK asset owners invested in alternatives vs 90% in the EU.

To many investors, the term Alternative Investment strikes panic with thoughts of high risk and massive losses, but is this actually the case? Liv-ex, fine wine’s global online exchange, just released its June market report, highlighting four consecutive months of 0.7% growth despite COVID, wars and recessionary fears. Over the medium and long term, wine continues to perform with the Liv-ex’s benchmark index up +23% in 2021 and averaging 12% over the last 15 years.  Given these impressive short and long-term returns, what is the risk?

A great way to determine risk would be to compare its annual standard deviation of monthly returns to traditional asset classes such as Equities and Bonds. Standard Deviation is similar to volatility and measures how widely prices are dispersed from the average. Simply put the lower the standard deviation the less risky the asset class.

We can clearly see from a risk perspective; wine is the most stable asset class with equities the most volatile.

To further validate this point, we can analyse the correlation between the S&P 500 and compare it to the Liv-ex 100 and 10-year treasuries. When testing correlations 0 – 0.2 would mean weak correlation between markets (excellent for diversification), 0.2-0.4 would be moderate correlation between markets and >0.4 would mean strong correlation between markets. If wine shows a weak correlation to the equity market it would further strengthen the argument that wine is low risk and not linked to economic cycles.

If we first look at the correlation between 10-year treasuries and the S&P 500 we can see there is a moderate to strong relationship between the two markets, except it is inverted so when values of stocks go up, values of bonds go down. Now interestingly with wine, a correlation coefficient of 0.12 demonstrates a weak relationship between the S&P 500 and the Liv-ex 100. This means that if the S&P 500 goes either up or down, the Liv-ex 100 is not affected. This would indicate that the wine market does not carry the same risks as the equity market. As mentioned previously this is a great diversification tool for any portfolio.

We have seen that wine is both low risk and does not track the equity market, so can we then deduce that wine outperforms in recessionary environments? To test this idea let’s see how the Liv-ex 100 performed compared to the S&P 500 in the last 3 bear markets. A bear market is defined as a drop of 20% or more from the previous peak.

From the chart, we can see that the Liv-ex 100 outperformed the S&P 500 in each of the bear markets.

 

So why does wine perform so well in recessions?

The price of fine wine is determined by different fundamentals. Investment wine’s value is based on critic scores, scarcity and prestige of the winemaker as opposed to income statements and growth outlook.

The supply of fine wine is relatively static due to terroir and legal constraints. On the flip side, demand for fine wine is increasing as people drink more fine wine than ever before and the investment market has broadened.

Fine wine is a tangible asset whose utility improves over time with decreasing supply of each vintage. This makes it suitable for wealth creation over the medium to long-term. Fine wine has “real value” in that it is a physical asset, unlike stocks and shares.

Wine is an inflation hedge as it is both a financial asset like gold and real-estate but also a consumable. Given wine’s low correlation to the equity market and inflation tracking properties, wine is a great investment in stagflation environments.