As investment markets continue to face heavy selling over uncertainties stemming from the coronavirus outbreak, this note seeks to provide context around the concerns and to offer a likely roadmap for how markets exit from this current panic.
But before we do, some words of comfort.
Global equity markets are presently already down between -15% and -20% year-to-date, but due to our caution over rapidly escalating asset prices and the build-up of debt, our recommended portfolios have been well diversified and more defensively positioned than many others.
Secondly, though we will likely face inconvenience in our day-to-day routine in the months ahead, the experts expect the impact of the virus on society to ameliorate as the year wears on.
We will come out the other side.
Lastly on a positive note, Australia remains well placed in an international context to handle the crisis given low levels of corporate and government debt and the comfort of recently rebounding house prices.
In simple terms, the coronavirus has exposed the global economy to a significant liquidity shock in a manner not dissimilar to the 2008 global financial crisis.
As governments attempt to limit the contagion through quarantine measures, the free movement of people and goods has been significantly curtailed and with that so too have people’s livelihoods.
Businesses exposed to the quarantine measures have seen cashflows stop overnight.
Airlines, tourism operators, restaurants, schools and universities, public recreation facilities, gymnasiums, transport operators, cinemas – the list goes on.
Cashflow drives everything, and when it stops, defaults and bankruptcies spike.
This is why global equity markets are down -15% YTD in the United States, -20% in Europe and -18% here in Australia.
That the virus is new and uncertain and that its ultimate degree of contagion is unknown only makes this harder for investment markets to find a level.
Markets hate uncertainty, and since the discovery of the virus only 10 weeks ago, investors have been faced with the need to rapidly curtail their New Year optimism for a playbook based on significant caution.
For the first time properly since the European debt crisis in 2012-13, investors are now being forced to consider not just return ON capital but return OF capital.
Some context on where we sit and what has happened –
- Global equity markets are down -15% to -20% year-to-date with the ASX200 -18% as of Tuesday morning
- In USD terms the ASX200 is -24% YTD and the second worst major equity market behind Brazil
- Australian equity indices have underperformed Australian bonds by -24% in 3-weeks and are now at their lowest point in over 3-years
- The Australian Dollar is back under 66c
- Australian 10-year government bond yields are at record lows of 0.60%
- US high-yield and levered loan indices have lost -9% and -6% from their highs
- The Bloomberg Industrial Metals index is -11% YTD
- The CBOE Volatility Index or VIX which measures US equity volatility closed Monday at its highest level since the GFC
Why does this all matter for investment portfolios ?
- The restriction of human movement as a means to combat this new virus will cause significant corporate and personal hardships to those whose livelihoods are curtailed by quarantine measures
- In California alone, it is estimated that almost 10% of all employment is linked to the two major west-coast ports, Los Angeles and Longbeach, where Q1 cargo volumes are estimated to be down 15-20% on 2019
- Expect to see job losses, rising personal and corporate bankruptcies and a significant fall in consumer confidence and domestic demand
- Global indebtedness since the GFC has skyrocketed meaning that loss of capital is now an increasing risk as the global economy is faced with this demand shock
- Arguably investors will now begin to countenance the prospect of a change in U.S Presidency come November 2020 and with that the rollback of corporate tax cuts and a likely $15/hour minimum wage – negative for U.S and global growth
Why Italy is important to watch
- The escalation in case numbers and subsequent nation-wide quarantine implemented as of Tuesday morning AEST is hugely important for multiple reasons
- Firstly, it’s a demonstration of what could, and likely will, happen in other Western nations such as Australia and the United States – schools, cinemas, nightclubs, gyms, swimming pools, museums and ski resorts have been shut until April 3rd at least and restaurants have operating hour restrictions to them
- Italy has the 4th highest net government debt to GDP in the world at 140%, behind only Japan at 250%, Greece at 180% and Lebanon.
- The longer the quarantine and global economic weakness persists, the threat of Italian sovereign debt default looms large and once again threatens to re-ignite the European debt issues we saw last in 2012-2013
What happens now?
- We think it’s important to accept that the 10-year bull run is now over. Major uptrends on important indices have been broken, and its near guaranteed that we will see the quarantine measures cause household and corporate cashflow duress in the months to come
- We should expect to see policy stimulus emerge, though this time it is likely to be in the form of government expenditures. Whether this has any effect on trampled consumer confidence remains to be seen
- Equity markets will at some point reach exhaustion selling, but the prospect of a major rebound in equity markets until the virus contagion seems fully controlled seems unlikely
- We would expect support in the S&P500 to come in around 2600 and in the 5000-5200 level on the ASX200 (a further 5-6% from Tuesday opening levels)
- From a positive standpoint, it seems highly likely that by the mid-point of 2020, health authorities will have been able to restrict contagion and that herd immunity will develop, meaning that equity markets could enjoy a countertrend bounce from attractive levels
What do we recommend?
- Avoid leverage and keep liquid – this crisis is one of cashflows
- Remain rational. Following our cautious asset allocations and reticence to chase yield, our portfolios have a strong chance to ride out this volatility and profit from the opportunities that arise in the months ahead
- Remain cautiously disposed, but willing to run down cash levels as opportunities arise – we believe there will be a good opportunity to add to equity positions in the coming months and our recommended asset weighting have significant room for us to do this
- We remain committed to most of our major Australian equity portfolio positions despite losses in many
- Webjet (WEB), Pendal (PDL), Nufarm (NUF) are net cash and Challenger (CGF) and Telstra (TLS) look likely to have excess capital
- We expect Downer (DOW) to sell assets and further alleviate its balance sheet stretch
How our recommended portfolios are performing through the sell-off?
- For the better part of 18 months we have taken a cynical view on the rapid debt build up globally and the stretch for yield from investors seeking to outdo diminishing term deposit rates
- Our portfolios hence have been defensively minded such that 2020 YTD we expect Balanced Investors adhering to the recommended portfolio weights would see portfolios down approximately 6% YTD (compares to a 19.14% gain in 2019)
We recognise that this is a very nervous time for investors. Though this is a rapidly moving situation, we do believe that the recent sell off is perhaps 75-80% of the way done and we are hopeful and expectant that opportunities will arise to take advantage of improving asset prices in the coming months.
We encourage you to follow our weekly commentary and video as a means for keeping abreast of our developing views.
If you have any queries or would like to speak with us regarding the above please contact Scott Averay, Senior Financial Advisor, Bentleys Wealth Advisors directly or on +61 2 9220 0700.
This information is general in nature and is provided by Bentleys Wealth Advisors. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.