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INVESTMENT SPOTLIGHT

Then out of left field, along comes a virus.

11 March 2020

As the coronavirus continues to dominate the headlines, news of the emergence of new clusters of infections outside China has caused jitters in global financial markets. Here’s our assessment of what’s happening and our investment view.

  Taking stock

2019 was an unusually strong year for returns with risk assets such as equities and defensive assets such as government bonds both delivering returns of well above their long-run averages.

We began 2020 thinking a share market correction was likely in the short term, but couldn’t think of a catalyst. Central banks had been keeping interest rates low and the global economy seemed to be at a gentle turning point. Tension in geopolitical issues such as US-Iran relations, Brexit and the US-China trade war had all eased.

Then on 31 December 2019, China began reporting cases of a new COVID-19 virus (Coronavirus) that began in Wuhan, Hubei Province. The share market shrugged off these early reports and continued to rally during January and the first three weeks of February as the virus spread, making an already over-valued market even more over-valued.

The world has seen many epidemics in the past and they tend to be short-lived, particularly those seen during this millennium (Severe Acute Respiratory Syndrome [SARS], Middle East Respiratory Syndrome [MERS], Swine Flu and Ebola) due to advances in treatment and vaccine development. These lessons learnt and the improving data probably goes some way to explain why equities rallied through January and into February as the virus spread.

Recently global markets have been more unsettled. We first noticed warning signs during the second week of company earnings updates (Reporting Season) in Australia when the number of management teams mentioning the risks from the virus outbreak rose.

Travel and tourism industries have been impacted, and with China being a manufacturing hub, the closure of cities and factories has hit global supply chains hard, restricting business activity.

Reaction by policymakers

Confidence is a vital component of economic behaviour that underpins financial markets and investor returns. It can be won over time, but it can also evaporate rapidly. Confidence has not yet collapsed as it did in the 2008 global financial crisis and central banks have moved swiftly to restore confidence. In Australia, the Reserve Bank of Australia (RBA) reduced interest rates by 0.25% in early March to provide support to economic activity. Similarly, the US Federal Reserve (the Fed) decided to cut their main interest rate by 0.50%, reflecting their desire to reduce the economic disruption stemming from the virus.

The People’s Bank of China (PBOC) has been relatively restrained to date but has provided $US174bn of liquidity to banks and $US4.4bn of special loans to affected firms. Additional government spending would be slower to roll-out but a useful tool if the economic consequences are likely to linger.

Where to from here?

News of a slowdown in the spread of the virus or the development of a vaccine would provide a timely shot in the arm for share markets even though both of these developments don’t seem likely in the near-term.

While our indicators continue to show that a recession isn’t imminent, the risks have clearly risen as travel and crowd gatherings around the world are becoming more restricted. Supply chains have also been blocked affecting manufacturing of consumer and industrial goods and this could easily feed into rising unemployment. Another sign that global demand is weakening can be seen in the collapse of the oil price – since the start of the year the oil price has fallen by around 50%.

Effective diversification is important, particularly in this environment. While investments in one part of a portfolio may suffer losses, other investments may remain stable or even increase in value. Our portfolios use a mix of different asset classes and a range of investments and fund managers with different investment styles to add layers of diversification.

It’s also important to retain a long-term focus during times of market turbulence. History has shown that markets have the ability to recover from significant downturns. Australian shares have returned over 9.7% per annum since their post- Global Financial Crisis low point, even including the recent market falls. So while the coronavirus is clearly impacting the global economy now, in the long-term this impact will most likely fade away.

 Your Portfolio:

The P3 Financial Planning Directors and Investment Committee have held a number of meetings in our office with analysts and portfolio managers from the different research houses and fund managers we deal with.

At this time, the more conservative managers in our portfolios are already holding cash after taking profits. Prior to the recent falls, valuations had been stretched and this period could see some great buying opportunities (in the near future), as markets are now down over 20% from their highs.

As with the last quarter of 2018, many of the moves you are considering have already been done. Cash has been increased, profits taken, and defensive assets rebalanced. Clients in pension phase have cash reserves to carry them through this volatile period, and for those in accumulation mode your regular contributions will see you increase your holdings.

We do not believe now is the time to be taking drastic action, outside of what has already been undertaken and planned for. The ‘news’ will be negative for some time and this will cause volatility. Volatility can be good.

We, and the research houses and managers we utilise, are cautious. It will be an uncertain period but as in previous years, markets could surprise us.

If you have any concerns or would like to discuss your portfolio please contact us on 07 3378 9681.

 

(References – Onepath)

 

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