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CIB Private Wealth Investment Managers, Paul Israel & Ian Wenham have provided this special Market Update in the wake of the COVID-19 crisis.
Given the large falls we have seen in markets we thought it was important to share our thoughts on where we are and where we think we are heading.
Key things for investors to bear in mind remain that: share market falls are normal; selling shares after a fall locks in a loss; share pullbacks provide opportunities; and to avoid getting thrown off a long-term strategy.
At times like these it is important to keep a sense of perspective
There is a good chance that the outlook will appear a good deal better in 6 months than it looks today, let alone in 5,10, or 15 – years’ time. That should provide the kind of perspective you require to navigate this period of market volatility successfully.
Clearly much has changed in a very short period of time. A recap of recent events as well as what lies ahead is provided below.
- Up until mid-February, financial markets adopted a measured response to the Corona virus, as China remained the epi-centre. Once Corona gathered momentum outside China, financial markets have commenced discounting increased risks of a much broader global slowdown / recession, lower corporate earnings and downgraded growth expectations.
- From a peak in equity markets on February 20th, within less than a month we find ourselves in a bear market i.e. down more than 20%. Extended markets needed an excuse for a correction and a Black Swan event such as a global pandemic, provided it.
- The speed, volatility and scale of the downturn reflects changes in market structure. Some of the factors contributing to this include a dramatic increase in Exchange Traded Funds (now 30% of market turnover), algorithmic and quant trading, zero brokerage for retail accounts in the US.
- There are generally three types of bear markets: Cyclical (1975, 1982), structural (GFC in 2008) and event (1987). Structural take the longest to recover, ie banks needed to deleverage and recapitalise post 2008, whereas cyclical and event tend to recover more quickly.
Looking ahead, we note that the Corona cycle appears to have a 2-3 month cycle. The breakout in Wuhan started in January and by mid to late March the situation appears to be normalising. Korea, Japan and Singapore appear to be following a similar paths. The key point is the Corona “crisis” has a definitive shelf life. There will be a vaccine!
Lessons from SARS
We note that despite Corona commencing in China, so far this calendar year, China has been the world’s best performing market. We suspect others will follow a similar trend once the Corona risks are seen to have peaked.
Below is an extract from some Macquarie Bank research titled lessons from SARS.
Covid-19 has had a larger impact on the world and markets than SARS, but we think some of the general principles from SARS also apply to this correction.
The SARS correction was short and sharp, with a low 4 months before the World Health Organisation said the crisis was over. Stocks rose 26% in the year after the low.
By the time the WHO said the SARS crisis was over, ASX stocks were up 12% and global stocks 20%.
Technology was the best performing sector after SARS. Software stocks rose 80% in the year after the SARS low.
Resource stocks outperformed industrials in the year after the SARS correction low. China has passed the worst, and its economy is coming back online, we think China is in a better position to stimulate. This should support resource stocks.
ASX stocks will follow the US. This is bad news now, as US stocks are correcting in anticipation of the rise in Covid-19 cases. Based on China’s experience, we suspect the growth in US cases peaks within weeks. This is not long, but the market’s horizon shortens in a correction. ASX stock returns should rebound with the US.
Fiscal and monetary stimulus should not be underestimated.
To support growth over the next few months, we have seen most western governments announce substantial fiscal spending programs designed to bring about stability to economies. The scale of the short term injection should not be underestimated.
Early this week the Australian Federal Government scaled-up its fiscal support by $66bn (~3.5% of GDP) with a second phase of policies targeting i) temporary income support to job seekers and 5.2m individuals already on welfare, ii) eligible businesses to receive at least $20k through the tax system and up to $100k.
Together with Phase one of the Government’s fiscal package (12 March), the second Phase of support amounts to around $85bn (4.5% of GDP). This scales-up to $189bn (~$10% of GDP) on the inclusion of recent Reserve Bank measures and somewhat further factoring-in recent state government initiatives.
Looking ahead, the Australian Government already indicated a third phase of fiscal stimulus will be coming soon. While unthinkable even a few weeks ago, UBS expect the Australian Government will have to very quickly consider following the much larger stimulus in the UK and Denmark (~10% to ~16% of GDP), & pay 75 -80% of workers’ salaries for at least 3 months.
How investors could benefit from the Coronavirus
As we have written, low interest rates are supportive for asset prices but they don’t render markets immune to sell offs from time to time. These sell offs are an opportunity for investors with cash on the sidelines.
In late February Warren Buffett, at the Berkshire Hathaway annual report, reaffirmed his belief that in long-term, equities will outperform.
“What we can say is that if something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments.”
Probably no other investor in history has been able to maintain such a consistent message of buying quality businesses at a reasonable price over such a long time
There will be significant downgrades to earnings over the next quarter, especially in tourism, education related businesses. However it is important to differentiate between what is “lost” v. “deferred” revenue and earnings.
We are beginning to see some excellent long term value propositions, including some of our core long term performers.
Markets with this much volatility may well move lower. But in the context of a fall in the ASX200 from 7200 to 4600, we are confident in predicting that upside / downside risk has now substantially switched. A month ago it was firmly skewed to the downside. Today on a 12 month view, it firmly skewed to the upside.
In Conclusion
The world is not about to end. We are currently in the washing machine with spin cycle running at full speed! Fortunately the spin cycle is relatively short.
- While may not be at the bottom, we are a lot closer than a month ago. The upside / downside risk has changed dramatically. It is perhaps 10% downside / 20% upside.
- We now have the opportunity to buy quality businesses at very attractive long term entry prices
- There is a good chance that the outlook will appear a good deal better in 6 months than it looks today. Event driven bear markets such as this one, given the backdrop of low interest rates, inflation and fiscal stimulus don’t normally have long duration.
- Australia’s major trading partner, China, is now moving into recovery mode. The impact of this should not be under-estimated on the outlook for the Australian economy
- Attractive investment opportunities have arisen in a multitude of large, mid and small cap stocks.
- International opportunities also appear attractive.
CIB Private Wealth specialises in the active management of Australian share portfolios and its disciplined investment approach delivers strong tax efficient returns for Individuals, Companies, Family Trusts and Superannuation Funds since its inception.
