CIB Private Wealth: Market Update


Updated July 9th 2020

In this update we examine the completed quarter, lesson from SARS, why Australia is well placed relative to most global peers, and what the new normal looks like, post the Coronavirus or COVID-19.

March Quarter

A recap of the March quarter:

  • 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 commenced discounting increased risks of a recession, and downgraded growth expectations.
  • The ASX 200 Accumulation Index finished down 23.1% for the quarter. The market peaked on the 20th February. The market fell 38% from top to bottom and some of the banks 56%, more than they fell in the GFC, in just a month. At the time of writing the market is up over 16% from its lows on the 23rd of March.
  • Historically, event-driven downturns, like COVID-19 have ended sooner than cyclical or structural downturns. Although they are often sharper, they generally passes faster. In contrast the Global Financial Crisis (GFC) was a structural downturn, and took longer to recover, as banks needed to deleverage and recapitalise post 2008.
  • Policymakers have significantly stepped up actual stimulus over the past month, reducing the risk of a credit meltdown. In addition the actions by Global central banks has made sure that when the “All Clear” sounds the era of ultra-low interest rates will continue and the stock market will price that in.

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.

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%.

Event driven bear markets such as this one, given the backdrop of low interest rates, low inflation and fiscal stimulus don’t normally have long duration.

Australia well positioned relative to Global peers

Our initial assessment of how the pandemic would evolve was based on the Asian experience. China, South Korea and Taiwan moved quite quickly to lock down the movement of citizens and close borders. This resulted in a month or so of disruption followed by a gradual return to business as usual. The breakout in Wuhan started in January and by late April the situation appears to be normalising.

Chart 1 – Chinese GDP fell dramatically in Q1, but the recovery is already underway, with industrial production up 32% in the month of March
Source: Macrobond, Macquarie

Coal consumption and traffic congestion suggests the Chinese economy is back to 90% of pre COVID – 19 levels. China’s experience suggests manufacturing, finance, construction, real estate, online sales, farming and auto sales are rebounding. However, the hospitality industry, airlines and mass transportation are slower in their return.

It’s worth noting that it is far easier to enforce a strict lockdown in more authoritarian political structures. In advanced western democracies, it has proved much more challenging to enforce the social distancing required to bring the coronavirus under control.

As a very infectious disease, once it is allowed to gather momentum, it has proved challenging to bring under control. Healthcare systems in many countries have been shown to be incapable of dealing with the scale of the problem. Testing standards have been inadequate, as demonstrated by Italy, Spain, the UK and most significantly, the United States.

Pleasingly, Australia seems to be a good chance of following the Asian model. By implementing a lockdown relatively early, enforcing social distancing and undertaking a comprehensive testing program, the signs are that within a month or so, the corona virus will be brought under control. From there, things can begin to normalise.

Chart 2 – Australia has seen the strongest fiscal response in the G20.
Source: IMF, AMP Capital

At a high level, it seems to us that those countries that have gone hard and early will have a distinct advantage over those that haven’t. The Asian region generally, including Australia, seem likely to emerge from this relatively unscathed. In contrast much of Europe and especially the US appear likely to suffer far more human and economic damage. As in the GFC, Australia finds itself in a good position with our economy firmly tied to Asia and China.

There are a number of reasons why we feel Australia is well positioned relative to global peers:

  • 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
  • The Australian Government has acted earlier in taking measures to contain the spread of the virus.
  • Australia has seen the strongest fiscal response in the G20. Loans and guarantees are helpful but they leave businesses more indebted, whereas actual fiscal stimulus provides a direct boost. So actual fiscal support is a better measure and on this front Australia at 10.6% of GDP has provided by far the strongest fiscal stimulus of G20 countries.
  • Influential Westpac economist Bill Evans said the jobseeker package would have a profound effect on unemployment. So much so that he has slashed his prediction of a jobless rate of 17% to 7% by the end of the year.

The next 3 to 6 months will be an economic, social and emotional roller coaster. Substantial increases in unemployment, decreases in economic activity, implementation of the vast stimulation programs will continue to impact daily lives. Financial markets are likely to continue to reflect this volatility.

What will the new normal look like?

We would not expect the new “normal” to be the same as the old “normal”. Trends that have evolved during the lockdown phase could reasonably be expected to remain. Working from home, teams working together remotely, online education, online shopping are likely to remain in place. International travel, especially the cruise ship industry, will take time to recover with longer term consequences for the tourism industry. The retail sector seems destined to structural change with consequences for the property sector.

The winners will include parts of the technology sector. Growth in use of the cloud, connectivity, movement of data are long term trends. Healthcare, on a global basis, will surely see substantial attention and investment in the aftermath of the corona virus. For Australia, our economic linkage with Asia continues to underwrite the long term success for our resources and
food sectors.

Investment Strategy

In the current uncertain and volatile time we find ourselves in, capital preservation is the main priority. From a stock selection perspective that involves being invested in companies where there is reasonable earnings visibility and predictability, and a solid financial structure.

Sectors that have a relatively high degree of sustainability include healthcare, consumer staples, food and beverage, utilities, some infrastructure and technology.

The present market volatility is also providing us with the opportunity to add to some of our core holdings at very attractive entry points. Some core holdings have traded 50% down on recent highs over the last month or so, including REA, Aristocrat, Macquarie Bank, Magellan.

As things stabilise, we are likely to reduce some exposure (not all) to some of the more defensive names that have performed well during the downturn (e.g. Resmed, CSL, Coles) and recycle funds into some of stocks that have seen a much bigger fall.

Finally, we continue to like resources, including BHP, and Northern Star. The combination of China in recovery mode, relatively high iron ore and gold prices and a low $A underpin corporate earnings.