25 Feb February 2020 | Economic and Financial Market Update
Written by David Graham, Senior Financial Planner, Mapp Fin CIMA® CFP®
Last week I attended a conference, where a range of presenters from different parts of the globe provided their view on a range of topics focusing on markets and economies. Not surprisingly, a significant part was in respect of the potential impact of the COVID-19 outbreak. As you can imagine, this was a fluid discussion, but it spanned a range of opinions and prognoses. These ranged from this being the ‘Black Swan’ event for economies and markets, to a more prevalent ‘this too shall pass’ analysis.
Both are probably right; it is a matter of degrees and timing, that are the only real points of contention. However, these points of contention are what really matter.
The pessimist case argues that the world of economies and markets are severely underestimating the potential impact. Recent news is tending to support this argument. While the rate of infection at the epicentre appears to be falling, there is growing evidence that the breadth of infection is more widely dispersed than first indicated. I don’t know a lot about the biology of viruses, but I do know a bit about numbers. The fact that cases are arising in parts of the world not previously thought at risk indicates the attempts at containment by quarantine is probably a failure. If the incubation period is longer than previously anticipated, it is ‘out’. The exponential rate of growth is likely to see the virus cross multiple geographic locations (the definition of Pandemic).
From an economic perspective, the short-term damage is already being done. Clearly, anything related to tourism & travel is being affected. However, as ‘the world’s factory’ (Hubei Province) has effectively been shut down, the trickle-down impact on other industries is yet to be fully appreciated. Moreover, as the spread continues and more countries implement quarantine procedures, this can only increase. Comparisons with the SARS virus of 2003 are less useful from and economic perspective as China was a relatively modest component of world trade at that time, only ascending to WTO membership in 2001.
No matter what direction the virus takes from here, you will begin to see more and more companies downgrading earnings and economists downgrading growth. One of the less tangible aspects of this is ‘confidence’. This can be a self-fulfilling prophecy. Strength in economic growth and investment markets, has been, in the recent past, an outcome of greater confidence, as various concerns are overcome i.e. Brexit and Presidential impeachments. A ‘Black Swan’ event, by its very nature (low probability, high impact), can erode confidence quickly. In recent weeks, we have seen equity markets overcome concerns and make new record highs. This dichotomy suggests markets are either under-appreciating the significance of the virus or looking through it. This is the essence of the range of opinions presented at the conference.
In suggesting they are both right, we believe an accumulation of bad news will see equity markets reach a ‘tipping point’. Thus, the odds of s significant market correction are relatively high. We know uncertainty is anathema for equity markets. We know valuations in certain parts of the world equity markets are high. It is easy to draw a metaphor with the recent bushfires, high fuel loads, an unfortunate spark etc.
The other side of the argument is equally plausible. Economic growth will be interrupted, but once the virus has passed, there is the potential for a significant period of economic ‘catch up’. That is, demand is being delayed, rather than destroyed. It is also clear that monetary authorities are awake to the economic impact. Chinese authorities are already increasing liquidity and cutting interest rates. It is now almost certain the RBA will also cut rates further, to support short term demand. One can assume monetary authorities around the world will again do ‘whatever it takes’ (the metaphorical rain that douses the fires).
For investors, this can present a conundrum. Do you ‘take cover’ and wait out the storm or do you ‘ride it out’? in deciding to ‘take cover’ this will be the first of two decision you need to make; when to sell and when to buy back. You will almost certainly get the timing of this wrong. To ‘ride it out’ requires some measure of faith but is the rational approach.
When the virus passes, and after authorities have continued to provide economic stimulus, levels of liquidity will be higher than they have been for some years. As we have seen, this money needs to go somewhere and ‘safe’ investments such as cash & bonds generate precious little return. Therefore, a rebound in markets may be sudden & swift.
If your timeframe is measured in months, taking cover may be the right approach. If it is measured in years, it is probably a mistake.
Over the coming weeks/months, you need to prepare for increased market volatility. We understand these events will create anxiety. However, we are confident ‘this too shall pass’.
Information current as at 23 February 2020.
This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date.