- Financial markets continue to trend down and display high levels of volatility on the back of coronavirus, exacerbated by a break-down in the Russia-OPEC oil relationship.
- The risk of deeper economic impact has risen, with key factors to watch being daily number of new coronavirus cases, measures of economic stress and policy stimulus measures.
- Investors should view this period as a ‘market disruption’.
- Markets and the economy are expected to rebound with the passing of the coronavirus in 6 to 12 months, however is dependant on containment measures.
- The Reserve Bank has lowered the cash rate to 0.25% and joined the government in providing a $189 billion cash injection to support vulnerable individuals, retirees, small business and attempt to cushion any economic shock.
- We are in unprecedented times, however history shows that market disruptions ultimately pass. Patience is vital, as selling out of the market after a fall generally locks in losses, increasing the risk of missing a rebound. Pull-backs should be viewed as a time of great opportunity.
The current state of investment markets
Uncertainty around the full impact of coronavirus is continuing to have a negative affect on the global investment markets.
In the US the S&P 500 Index has retracted from its highs of 3,386 points in February to 2,305, a fall of 33.93% (as at 23rd March). While the Dow Jones has wiped 37.09% from its February highs. The real impact of this has been somewhat softened for Australian investors by the falling Australian dollar, now sitting at $0.58 US.
Here in Australia we have not been immune, seeing the ASX 200 retract 36.53% from its record high of 7,162 points in February, to 4,546 (as at 23rd March). The All Ordinaries Index has also fallen 37.09%.
During this same period, we have seen extreme levels of volatility as investment markets attempt to interpret economic data and the virus, against decisions being made by policy makers to limit the financial impact. Government policies and initiatives have thus far failed to stem the market fear caused by uncertainty around the potential impact of COVID-19.
In bond markets, rising prices (as yields fall) are helping to offset falling equity prices in defensive, moderately defensive, balanced and growth portfolios. We would expect the markets’ long-term dynamics of rising equity prices and falling bond prices (as yields increase) to hold during an eventual equity market rebound.
Consensus is that it is not out of the question that U.S. Treasury rates could fall below 0%. This will have ramifications for global yields, including that of Australia which has seen yields tumble to less than 1% in recent days.
This may all sound relatively bleak, however this particular market event is fundamentally different from that of the global financial crisis (GFC) and may instead be viewed as a ‘market disruption’.
The economic environment
The coming weeks will provide a greater understanding of the full impact of coronavirus on the global economy, as governments continue their containment efforts and implement policies to soften the financial impacts to their respective economies.
In China we saw a reduction of 17% to manufacturing that will ultimately impact its gross domestic product (GDP), and it is our opinion that this situation will be common to other economies as coronavirus spreads. It is believed that if peak infections outside of China crest during April-May, a timeline similar to that experienced by China, it is likely that the US and Australia will experience a deep and short-term recession, with the economies making a full recovery once coronavirus has run its course. However, this is dependent on the containment efforts being as effective as that of China and also reliant on potentially mis-reported data.
Once the disruption passes however and daily life regains some form of normalcy, the global economy and investment markets will begin their recovery. While there may be after-shocks throughout this period of recovery, this may be within 6 to 12 months.
Markets are likely to bottom with a peak in daily new cases of coronavirus, at which point the full extent of the global economic impact will be known. Declining new cases in China and a steady return to manufacturing are also a measure of what can be expected elsewhere.
The secondary effects of the coronavirus outbreak, as well as a potential supply shock from the fraying of an alliance between Russia and the Organization of the Petroleum Exporting Countries (OPEC) that limited production, is highlighted by the 45% collapse in oil prices since mid-January. Ultimately lower petrol prices will be a good thing as this will boost consumer spending when the virus passes, but for now all the focus is on the downside of lower oil prices – debt problems and less business investment by producers.
Australian economic outlook
The Australian economy was already in a fragile position following the recent bushfires, expecting a negative March quarter (0.20% contraction) on the back of the hit to tourism, education and commodity exports from the slump in China.
The coronavirus outbreak is likely to increase this vulnerability, with slower-than-expected Chinese business resumption and Australian government containment efforts hurting certain key sectors. It is likely that we will also see a contraction in the June quarter too.
In an effort to cushion the economic impact of coronavirus, the Government in conjunction with the Reserve Bank has announced a further $189 billion cash injection into the economy. This includes $17.6 billion for the Government’s first economic stimulus package, $90 billion from the RBA and $15 billion from the Government to deliver easier access to finance, and a $66.1 billion economic support package. It is these measures and lessons learned during the GFC that will assist economies to effectively navigate this challenging period.
Much of this fiscal relief will be targeted in nature, including making cash payments to small businesses and expanding asset write-offs for firms. For the government, this will mean temporarily putting aside its commitment towards achieving a budget surplus by 2020.
Even with these measures in place a deep recession is likely, albeit short-term with a recovery in the second half of 2020 with effective containment efforts.
Investors should be viewing this period as a ‘disruption’ as opposed to a traditional recession, as recessions are typically preceded by excess and monetary tightening.
As worrisome as the rapid share market falls have been, it is important to remember that, unlike the GFC, the underlying structures of the global financial system remain strong.
The GFC was exacerbated by compromised underlying factors within the financial system that required a structural realignment of markets. Such a dynamic isn’t in play with coronavirus, recovery from which is more likely akin to that of a disaster-relief effort.
It is likely that markets are awaiting the peak of daily new cases of coronavirus, thereby allowing the full impact to be accurately priced in. Only when valid data makes it clear that we’ve reached the peak in new cases of COVID-19 can the markets determine whether they’ve reacted appropriately to the crisis.
With fundamentals of the global economy strong prior to the COVID-19 outbreak, investment markets are expected to rebound as the virus passes peak daily new cases.
What to watch
Shares will bottom when there is confidence that the worst is over in terms of the economic impact from the virus and its largely factored in. So, the debate is largely now about how significant the hit to growth will be, and this relates to how long the virus will weigh on global growth and any secondary effects it may cause. In this regard, the key things to watch are as follows:
- A peak in the number of new cases
- News of successful vaccines or anti-virals
- Whether governments switch from containment to treatment as required
- Timely economic indicators e.g. jobless claims and weekly consumer confidence data in the US and Australia
- Measures of corporate stress e.g. spreads between corporate bond yields and government bond yields
- Measures of household stress e.g. unemployment and non-performing loans
- Measures of market stress e.g. bank funding costs as measured by the gap between 3-month rates and central bank rates. These have risen but are well below GFC levels.
The monetary and fiscal policies are also critical in terms of minimising the impact on vulnerable businesses and households from the coronavirus disruption, ensuring financial markets remain liquid and driving a quick recovery once the threat from the virus is over. This is something to be monitored, but policy makers seem to be moving in the right direction.
What does it all mean for investors?
The rapidity of the fall in share markets has been scary. In our view the key things for investors to bear in mind are as follows:
- Periodic sharp falls in share markets are healthy and normal. With the long-term trend ultimately remaining up & providing higher returns than other more stable assets.
- Selling shares or switching to a more conservative investment strategy after a major fall generally locks in a loss.
- When shares fall, they are cheaper and offer higher long-term return prospects. So, the key is to look for opportunities the pullback provides. It’s impossible to time the bottom but one way to do it is to dollar-cost-average in over time.
- Shares and other related assets bottom at the point of maximum bearishness, ie, just when you feel most negative towards them.
- Generally, the best way to stick to an appropriate long-term investment strategy, let alone see the opportunities that are thrown up in rough times, is to turn down the noise.
Nine guidelines for investors to keep in mind
- Make the most of the power of compound interest
- Don’t get thrown off by the cycle
- Invest for the long-term
- Diversification reduces asset-specific risk
- Turn down the noise
- Timing the market is fraught with danger. Selling after a fall locks in a loss, and being out of the market for the recovery can further impact a portfolio’s ability to survive a downturn
- Beware the crowd at extremes; markets bottom at the point of maximum bearishness
- Focus on investments you understand
- Seek advice
Should you have any questions regarding the above or wish to discuss with your Wealth Consultant, please call DPM Financial Services on 1800 376 376 or book an online/phone appointment here.
Information current as of 24/03/2020.
General advice warning
While care has been taken in the preparation of the market and economic snapshot, DPM Financial Services Ltd (AFSL 239690) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts.
This market and economic snapshot has been prepared for the purpose of providing general information, without taking into account your specific objectives, financial situation or needs. Before making any investment decisions, consider the appropriateness of the information and seek professional advice that has regard to objectives, financial situation and needs.