Crisis Transitioning to Constructive Opportunity
Posted 18 March 20
COVID 19, Where Things Stand
The world is quickly coming to the realisation that it needs to co-ordinate its COVID 19 response across all society channels; health, social, financial and economic. All channels are now finally starting to be actively managed through the G7 and hopefully soon the G20.
With the exception of South Korea, testing and hence reliable data is weak. One data set which is not prone to manipulation is 'reported deaths'. South Korea has reported 84 deaths and approximately 8,413 cases for a case fatality rate of 0.9%. Singapore has had zero deaths. The reasons are various, but early testing and treatment appear the key, but as a corollary, it also means the authorities have a more accurate gauge on numbers and what they are managing now and going forward. There are also some specific cohort differences in South Korea to other countries (more women infected than men, and younger population). On the other hand, the US is reporting 6522 cases and 116 deaths. It is more probable though that the infected cases are closer to >30,000 and growing. What this underscores is that without more meaningful tested case data, authorities are flying 'blind' and financial markets know this, and they are petrified in the face of a data vacuum. The US is the key as it is a USD$22 trillion output economy. Whilst undoubtedly slow to the required policy mark, it appears to be catching up quickly at both the State and Federal level, which hopefully sees a similar result to South Korea (which was initially slow in to policy response, but then rapidly implemented tough policy the infection and death rates have fallen accordingly).
The world view in Figure 1 is poor, other than for China. All other regions are registering growth in infected case numbers.
As we can see in Figure 2 below, we are addressing a virus which has the combination of high infection rate (x axis) and medium mortality rate (y axis). The challenge therefore is to control its spread through the community so as not to inundate the health system and ensure the most vulnerable are protected.
In terms of age of cases, we observe a major difference between Asia and Europe (Figure 3). South Korea and China only had 10% and 12% respectively of people over 70 years of age, whereas Italy is at 38%. Italy has the oldest population in Europe with 29% of the population over 60 years of age compared with South Korea where 19% is 60 years or older.
The dismal statistic is the case mortality rate (Figure 4) and the skew to those 70 years of age or older. With western countries having older populations and this cohort presenting a high infection contribution, this clearly indicates the issue for the senior population and the ability of the healthcare system to effectively function.
Financial Markets, The Economy - Our Strategy
There is no doubt that COVID 19 is an 'asteroid' event for markets and economies with the consequence that businesses cashflows are getting cratered out - the key question is for how long? As of writing and acknowledging this is a quickly evolving heath issue, we think it prudent to expect significantly cratered business cashflow and earnings till August 2020 with a reasonable pickup from there onwards. Importantly, even if the COVID 19 health outcomes end up being moderate, this is still a minimum 4 month event for corporate cashflow and the flow-on effects to employment and households. Whilst clearly a horrible outcome for businesses and with stresses only beginning to emerge, there is reason for extreme caution, but also to have an eye to beyond crisis.
We note the following in terms of our current approach to Australian Equities:
- In January we had both reduced exposure to Australian Equities and rebalanced (sold) excess weight holdings due to the 28% gain over the preceding 12 months.
- Due to the recent significant downward price movement, our Australian Equity strategy is below its already conservative weight.
- We have over the last few weeks deferred any further investment, but view certain elements of the strategy as being attractive to purchase and will incrementally do so - importantly, we are not adding any additional risk exposure from where we were in January.
- There are some companies we have sought to acquire over time but valuation has precluded us from doing so - such companies are now attractive to begin some acquisition.
In relation to our current Global Equities approach, we note:
- Global Equity markets have experienced similar falls to the Australian market.
- A counter effect to this valuation effect has been the depreciation of the AUD to the USD since the beginning of January - this currency effect has provided a positive portfolio return of 13% during this extreme volatility to give an overall position that our global equity strategy is down 3.9% in AUD terms since 1 July 2019 (Figure 6)
- We will be very company specific and intend to make some quite modest adjustments to the Global Equity strategy but we do not see a case to increase risk.
- With the AUD/USD at $0.6018, we are not inclined to add unhedged US equity exposure at this point in time
In money and bond markets, we are witnessing tight/constrained conditions and central banks working very hard to ensure liquidity for the financial system. In senior bank debt and subordinated bank debt we have seen widening in margins but not at crisis levels. In the ASX listed bank hybrids there has been significant expansion of margins from mid 2% to mid 6% as retail investors liquidate. These movement are significant. This provides some opportunity for medium term investment.
What is apparent is that credit markets are wholly reliant on central banks, and again in this regard, the US Federal Reserve. At the fiscal level, we are likely to see stimulus out of the US of around $1 trillion. This implies Australia will need both stimulus and a business support program up to at least $85 billion and depending on duration, up to $120 billion, of which $21 billion has occurred. Such fiscal stimulus and support would soothe short term money markets. The risk to manage is ensuring that economic crisis does not become a financial credit crisis. At figures 7 and 8 we can see the risk margin that banks in both Australia and the US are seeking in order to lend between one another - a gauge of bank confidence. It is highly elevated, but most notably in the US. Central banks are doing a lot of immediate soothing, well practised from the GFC and this is proving reasonably effective (but remains a caution).
The listed property property sector has likewise been adversely effected. Industrial property has generally faired the best (down 25% from highs), followed by office, with large retail off 60% from its highs. We retain our focus of the last 8 years to industrial and some fringe CBD office. It should be noted that the listed property sector is in a healthy balance position when compared to the GFC 11 years ago. They're gearing is much lower and many have raised significant equity over the last few months to ensure gearing around 30%. Should we see a further significant overshoot on the downside, we will consider some further risk exposure to property.
Our Core Multi Asset Allocation Strategy remains conservatively positioned, a stance we have held for some time now. We don't think any change to this position is warranted at this stage given the balance of risks and we will seek to maintain these positions. As dynamic risk managers, this is not a fixed position and we constantly assessing based on material changes and overshooting by markets.
The Future Beyond Crisis
In crisis, it is human nature to concentrate all efforts and resources on the immediate challenges and problems that need addressing. That said, an eye needs to be turned to the future leading up and beyond the crisis. It is becoming very clear that the world economy is going to be left with low interest rates, be awash with liquidity, but most importantly, have huge fiscal stimulus (and ‘helicopter’ money). We of course need to be careful with the key assumptions concerning this crisis, but when the economy restarts (say August 2020), there will be a lot of fuel to kick the economy along. We saw Australia provide cash handouts during the GFC, which was a mini version of ‘helicopter’ money. The COVID 19 version of ‘helicopter’ money is likely to be mega scale, and with that comes a changed paradigm for investment markets as fiscal policy takes centre stage. Where equity and bond markets have benefited over the last 30 years from declining bond rates, massive fiscal spending in response to COVID 19 may see this somewhat reverse. In short, higher bond rates and a new set of challenges for equity and property markets.
Peace of Mind Investing
Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated over a long period our ability to manage investments through both the good times and bad by keeping the client at the centre of our business.
For more information on our approach to investment strategy or any other inquiries, please contact us on +613 9655 5000.
Photo by Cheng Feng