Today the Australian sharemarket has closed below 6000 points, with the largest one-day fall since the GFC, and at the time of writing the US Market Futures point to a similar day over there.
It’s no surprise that markets are reacting badly to the uncertainty around the Coronavirus, and the impact that this is having on global economic activity.
As I intimated in the last email, I expect volatility in financial markets to remain high, particularly whilst there is a high level of economic uncertainty, but probably more importantly, individual anxiety.
We can see a glimpse of how financial markets react in times of uncertainty through the lens of how individuals have reacted with the panic buying of toilet paper, and other household items.
This is a stark reminder of herd mentality, and the impact of the unknown on the human psyche. We are at our core essentially pack animals, so we often look to the actions of others for confirmation or support for our own actions.
In regard to the Coronavirus, the flight or fight response is kicking in, as evident in the behaviour in local supermarkets, and in the sharemarket.
Markets Don’t Like Uncertainty
First and foremost it is important to understand that financial markets don’t like uncertainty, and that is what we are witnessing here. Again, as I intimated in my last email, such reactions and volatility are not without precedent.
The issue for many investors, is that they have not experienced markets reacting as they are now, certainly not since 2008, however even in 2008, these events were not without precedent. We have for the last 10 years at least enjoyed some of the strongest markets in history, and as in the past, and, as will be in the future, these things always end.
For people that have not experienced such market volatility, these times can certainly be unnerving, and this time it is also coupled with some uncertainty around our health, and how we as individuals and family members might fare over the next 12 months or so.
The one thing that we can be sure is that governments globally will seek to do everything in their power to ease economic uncertainty, and to the degree that they can, ensure that they are acting to bring about some containment, and some semblance of sensibility to the population at large.
Some Thoughts From A Fund Manager
Without rehashing a lot of what has already been said about the situation, I have provided below a few thoughts from Roger Montgomery, a portfolio manager for whom we have a great deal of respect.
“The problem for investors and for markets is the number of unknowns. In the absence of reliable data, investors cannot make confident forecasts about the future. In an environment that has no data to which to anchor, fear and uncertainty drive decision making. Many professional investors will reduce their risk any way their mandates permit and market volatility will become entrenched.
Only when reliable data is available will investors confidently look to the freedom beyond the fear.
What we can surmise.
If a patient presents to their doctor with COVID-19, and the doctor responds reassuringly; “its ok we’ve cut interest rates”, the patient isn’t going to be cured.
With borders closing, travel being cancelled or postponed, workers locked out or forced to stay home because their children’s schools have been closed, and with millions of people quarantined in their homes, rate cuts aren’t likely to inspire the ‘animal spirits’ that would normally act as a transmission mechanism between rate cuts and corporate investment and retail consumption.
We also know, as discussed above, that this Coronavirus has a much higher mortality rate than seasonal influenza and a higher infection rate. And SARS pales into insignificance on those same metrics. The combination of higher mortality and infection rates, understandably, inspires fear.
But fear for the economy is not the issue. When consumers and citizens fear for their health, which they are now doing – noting the cancelled travel and disinfectant shortages – assumptions about normal market dynamics should be suspended.
There is a real impact on business from this outbreak. Sydney airport is virtually empty. Some international flights are departing Sydney at less than a third of capacity (some NZ flights are full) and toilet rolls are running off the shelves.
We believe the cheaper prices at which to buy high quality companies is a distinct possibility in coming weeks.
The real contagion for us, is not the virus itself but the possibility that fear in equities spreads to credit markets.
If the virus disrupts business for long enough to adversely impact the cash flows of highly indebted corporates, the desire to refinance a record amount of CCC-rated debt due this year could evaporate. Any tightening of liquidity could trigger a credit event or crisis. If a credit event does transpire, or even if the fear of such an event emerges, substantially lower shares prices are possible.
Beyond that of course, ‘this too will pass’. I can almost guarantee (no-one can ever actually guarantee) that we won’t be talking about Coronavirus as an influence on the stock market in five years’ time. With that in mind, it makes perfect sense to be looking for opportunities among the malaise.
And the lower the prices, the higher our return.
The last few weeks have been witness to turbulence unfamiliar to many investors, especially those that that only began investing professionally after the GFC. And some of the fastest declines in share prices ever have ruffled confidence, especially those in the camp that believed lower interest rates were supportive for asset prices (correct) and believed low interest rates created an immunity against market declines (incorrect).
As an aside, it is right to assume that low interest rates are supportive for asset prices, but it is wrong to conclude low interest rates make markets immune to falls.
And on top of all that the Federal Treasury suggests the bushfires and the virus could subtract 0.7 percentage points from Australia’s March quarter GDP growth. This would send the economy into reverse and if it continues into the last quarter of the financial year, an official recession is possible.
Positioning for the worst and positioning for the best
We currently believe that a risk of even lower prices exists. In the absence of reliable data and with the worst of the news flow and official responses potentially still ahead, the possibility of a panic worse than the pandemic is very high.
With that in mind and armed with cash, and a target list of quality companies, Montgomery is in an enviable position compared to fully invested peers.
Quality will remain important because not all stocks are going to bounce after the worst of the news flow is over. An investor in a portfolio of expensive, high beta, high hope, but low-quality companies, may not enjoy a substantial recovery”.
(Source: Roger Montgomery, Montgomery Asset Management – 07 March 2020)
Yes, there are a lot of moving parts to this, and no doubt for some, there will be increased anxiety. The thoughts of Roger (and others) mirror our view of the situation as we currently know of it, and again, we reiterate the importance of diversified portfolio’s.
Importantly however, if you have any questions, or would like to know how the current situation might impact you, call or email to ask.
Kind regards and…. enjoy good things.