Wow, what a difference a few weeks can make! Less than 3 weeks ago I attended an investment conference where a major topic of discussion was the impact the Coronavirus would have on the global economy and financial markets in 2020.
While it was clear that the outbreak was a serious issue and would cause a slowdown in the first half of 2020, the consensus was to look through the slowdown and remain invested with a diversified asset allocation despite the virus. The consensus was we would have a big rebound in activity in the second half of the year. Just 3 weeks ago both the US and Australian stock markets were flirting with record highs and the US 10 year treasury yield was sitting at 1.5%.
Since then, the market reaction to the rising number of new COVID-19 cases outside of China has been brutal. Central banks have been swift to respond and fiscal support is expected this week, but markets are now in the most serious panic we have seen since the GFC.
What are they worried about? While the coronavirus outbreak appears to have stabilised in China, the fear is that it may yet wreak havoc in other major centres of global economic activity – Europe and the United States – over coming weeks.
Indeed, uncertainty stems from the fact the coronavirus remains distinct from the pattern of past influenza outbreaks that have afflicted the world. While the death rate among those infected is still being debated (estimated anywhere between 0.5% and 3%), the coronavirus is somewhere between the 2003 SARS outbreak and 2009 swine flu outbreaks in terms of lethality, which had death rates of 10% and 0.03% respectively.
While the more lethal SARS outbreak ended up infecting a relatively tiny 8,000 people worldwide, the swine flu affected around 1 billion, or 15% of the world’s population. SARS was not labelled a “pandemic” by the World Health Organisation, whereas swine flu was.
The table below shows infection and death rates for major disease episodes of the last 100 years. The Spanish flu of 1918 combined extremely high infection and mortality rates to produce a huge number of deaths. Other outbreaks have had either high infection rates or high mortality rates, but have managed to avoid the catastrophic combination of the two.
For context, the common annual flu affects around 400 million (5%) of the global population each year, with a death rate of around 0.1% (500,000 people) each year.
History of Past Influenza Outbreaks
Source: WHO Coronavirus statistics from one week ago. Confirmed cases 105,981 at time of writing.
Given the reasonably high coronavirus death rate, the hope is that global infection rates remain much closer to that of SARS than the 2009 swine flu and common annual flu. Another possibility is that the fatality rate ends up being much lower than currently evident – closer to swine flu – if allowance is made for many milder cases going unreported. I suspect this will prove to be the case.
For markets, what matters especially now is how bad conditions become in the world’s most important economy, the United States. While the U.S. had 6% (60 million) of worldwide swine flu cases, it had only 0.3% (27) of SARS cases. But even the 2009 swine flu outbreak ended up not as bad as feared in the U.S. and failed to derail the post-GFC rebound in both its economy and stock market over the year. Indeed, the World Health Organisation was criticised for creating undue fear in 2009, which perhaps explains its reticence to date in labelling the coronavirus a pandemic.
At the time of writing, the U.S. had only 424, or 0.1%, of coronavirus cases. Again, we can only hope the U.S. outcome is closer to that of SARS than of swine flu.
Either way, economic data around the world is likely to be universally bad in coming weeks as production and tourism are disrupted. China’s PMI reports last week on both manufacturing and services were shocking (composite PMI covering both services and manufacturing sank to 28.9!). Trying to help will be central banks, with the Fed last week announcing an emergency 50bps cut. The RBA also cut rates by 0.25%.
The RBA will cut rates to get ahead of the likely slump in both business and consumer confidence in the months ahead. A follow-up rate cut in May is anticipated, with “quantitative easing” now at least a 40% chance in the second half of the year.
Will local rate cuts hurt rather than help confidence? Perhaps, but in a time of apparent crisis, the RBA will want to feel ahead not behind the curve. Indeed, Australia now faces its greatest risk of recession since the global financial crisis, with private demand already weak, and with much less fiscal and monetary firepower to respond.
Federal Governments are presently preparing fiscal stimulus packages which will be needed to help economies through the current crisis and to restore confidence. We expect them to act quickly and decisively.
For the first time since 2008-9, we believe the worst-case scenario here is a global recession. There are many commentators who, using “best guess epidemiology”, believe 96,000,000 infections and up to 500,000 deaths in the US it is now inevitable over the next few months as they believe the virus is spreading exponentially. While financial markets are in free-fall trying to price this risk they have still not fully priced this scenario and if it were to transpire, equity markets will likely get much worse from here.
While this is a possibility, I don’t believe it is inevitable. I have that opinion because human behaviour has been adapting since the virus breakout. Cases in China have fallen by a factor of 30 in the last month, they are not growing exponentially. Singapore and Hong Kong with diligent management have been able to stop the spread quickly in its tracks. We can protect those most at risk (the elderly and sick), but health authorities cannot afford to play politics. How they react will determine how long the economic weakness lasts for and how quickly we can recover.
So what does all this mean for your financial plans?
We have been in this situation many times previously. When the financial system is bending due to a shock as it currently is, we typically don’t like making too many rash decisions. While you may think it is now obvious share markets will keep falling, Government intervention and case counts getting under control could cause a violent rally in the opposite direction as the fear subsides.
The virus scare will pass, but the lower interest rates will likely be with us for years. On the other side of this crisis, the problem of generating enough income in a world of zero or likely now negative interest rates is going to be a huge problem. I suspect assets with sustainable yields will likely prove even more valuable in the future and be bid up quickly again.
In the process of portfolio construction, you have a well-considered investment strategy and asset allocation that is diversified and designed to meet your goals and longer-term objectives. Your asset allocation was a result of careful consideration of your personal circumstances and this should be remembered during these times of panic in financial markets. So most investors should “stay the course” and stick with their longer-term strategy.
It is at times like these, particularly for those who keep an eye on your investment portfolios frequently, that investing can feel similar to riding an uncontrollable emotional rollercoaster.
For our older clients who rely on their portfolio’s to fund living expenses, there should be plenty of defensive assets in your portfolio such as cash reserves and bonds that will perform well during this period of volatility and see us through it. While we were not expecting this shock, we were aware it was late in the business cycle so equity weightings have typically been lower than what they were 3-4 years ago. On the other side of the crisis, there should be plenty of opportunities to set your portfolio up for the years ahead into the inevitable rebound.
For our younger clients, you are accumulating wealth in the longer term, while too early to be taking risk yet, this is likely to be an opportunity for you to purchase quality assets in a dislocated market where there will be mispricings. In the years ahead, it will likely be looked back upon as a good opportunity to have invested. We would hope you will be net buyers of quality growth assets during this period.
If you feel the need to reassess your portfolio allocation please contact your adviser to discuss.
To be clear, “staying the course” is difficult and does not result in immunity against the strong fluctuations in the value of your investment portfolio. But abandoning a long-term plan – a carefully thought-through plan put together by your financial adviser with your goals in mind – can be even more detrimental to your investment portfolio. Staying the course is what keeps you in a position to benefit when a challenging period passes.
We will continue to communicate with you as often as necessary through this crisis. I expect we will record a podcast tomorrow with an update so we can reach as many of you as possible with the most up to date thinking.
– James Vandeloo