What does Coronavirus mean for our investments?

The coronavirus outbreak is a fast-paced story, hard to keep up with in real time, let alone write sensibly about in a document designed to have a longer shelf-life than the next day or so. Because of that I want to look in a broad-brush way at what we can learn from this catastrophic event: how the authorities have reacted; what the economic implications are; how the current market situation compares with other bear markets; what the longer-term implications may be; who could be the winners and losers;  and how we should respond as investors. Finally, I will revisit my New Year fund picks.

On a war footing

The government and central bank response, around the world but notably in the US, has been unprecedented. The $2trn fiscal stimulus package that the US Congress finally agreed is roughly two and a half times the size of the Obama measures in 2008 and should be easily funded thanks to the Federal Reserve’s implementation of ‘QE infinity’. The government can spend what it likes to protect businesses and individuals because the Fed has promised to buy any bonds it issues, keeping a lid on yields in the way that Japan has been managing its borrowing costs for some time now. Here in the UK, new Chancellor Rishi Sunak has been equally bold, acting as an essentially unconstrained backstop for however long it takes.

So, lessons have been learned from the financial crisis: decisive action, performed at pace and without limit. What matters now is that the money gets where it is needed without delay. The chart below shows one aspect of the policy response - interest rates are back to zero, a dozen years after they were taken there as an ‘emergency’ measure. It is hard to see them getting off the floor for a long while to come.

Interest rates fall back to zero

Source: Refinitiv, as at 31.3.20

Past performance is not a reliable indicator of future returns. Overseas investments will be affected by movements in currency exchange rates.

Global recession: how deep, how long?

So, the key question, now the authorities have acted, is whether the monetary and fiscal measures they have taken will be enough to offset the inevitable recession that suppression of the outbreak will cause. Shutting down the global economy for even a short period is unprecedented and no-one really knows how long and how deep the downturn will be. The early signals are not encouraging as the chart below shows. The collapse in Chinese retail sales during its February lockdown offers a template for all the other countries which have adopted this radical approach to containing the disease.

GDP forecasts are changing so quickly that they will soon be out of date. More important is the speed of the rebound. The hopes for a V-shaped economic recovery that we hung onto in the ‘denial’ phase are probably too optimistic, although the speed with which China has started to get back to work suggests that the rebound may yet surprise us. Unlike with a natural disaster (such as the 2011 Fukushima earthquake and tsunami) the supply-side infrastructure remains intact and demand for many goods and services should be resilient.

China retail sales show the way ahead

Source: Refinitiv, as at 31.3.20. 12-month percentage change

Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets.

Learning from history

Moving onto the market response to the health and economic crises, we have suffered one of, if not the, most savage bear markets of our lifetimes. Certainly, the speed of the drop is unprecedented. Figures from Goldman Sachs suggest that the 22 days it took for the S&P 500 index to fall by 20% (the commonly accepted definition of a bear market) has never been beaten. It was faster than in both 1929 and 1987.

When it comes to comparisons with previous bear markets, some hope can be gleaned from history. In the same note, Goldman’s strategist Peter Oppenheimer categorised all the bear markets since the early 1800s as structural, cyclical or event-driven. Which bucket the latest fall sits in may decide whether this is a deep slump from which recovery is painfully slow or a short and relatively sharp drop from which we rapidly get back to business as usual.

Structural bear markets, triggered by financial imbalances and bubbles, are the deepest and longest. On average, they have seen a 57% peak to trough decline with a 111-month recovery to the previous high as the chart below shows. By contrast, cyclical bears, caused by the dampening effect of rising interest rates, tend to see a 31% drop and are done and dusted in 50 months. By far the most benign type of bear market is the event-driven one, caused by war or a commodity price shock or technical dislocation in markets. These fall by 29% on average and bounce back within 15 months.

We don’t know which template this bear market will follow but it feels more event-driven than structural or cyclical. Let’s hope so.

Event-driven bear markets recover quickly

Source: Goldman Sachs, March 2020. Performance of S&P 500

Past performance is not a reliable indicator of future returns. Overseas investments will be affected by movements in currency exchange rates.

Long term implications

Looking further into the future, it is worth considering what some of the longer-term implications of coronavirus might be. Here are a handful of ideas:

  • Tax. Corporate tax rates have fallen in recent years. That process will probably reverse as governments seek to recoup some of the money they will borrow and spend this year. The way that the 2017 US tax cuts were diverted into share buybacks won’t be accepted this time around.
  • Regulation. The return of interventionist governments suggests that the era of de-regulation is over. Companies will be pushed towards more socially beneficial behaviours. This is probably a good thing, but it will come at a cost to shareholders.
  • Inflation. Rising prices will not necessarily follow a big uptick in government spending. They will only do so once end-consumer demand and company investment use up the current slack in the economy. But longer-term, I see a return to a more inflationary environment.

Sector winners and losers

Who might some of the winners and losers be in future? My initial thoughts are that the way we work has changed irrevocably. Many service sector companies will realise that they can operate effectively with many more staff working remotely. That will fuel demand for robust data and communications systems. Technology and telecoms will be strong growth areas. So, too, will healthcare. The underinvestment in the NHS will most likely be reversed.

Areas that have been hard hit but may bounce back quickly include industrials and miners, which will get back to work quickly. Retail should, on the face of it, do the same but the sector was in dire straits before the virus struck and its structural problems will still be there on the other side of the outbreak. Travel and hospitality businesses will be OK as long as they can get through the shutdown - hence the vocal demands for help from the airlines. The area that looks challenged long-term is financials. With interest rates remaining on the floor, it will be hard for banks to make money.

Managing through volatility

Markets have been unbelievably volatile in the past month or so. As the chart here shows, we have seen spectacular rises and falls in the S&P 500, often on consecutive days. This is how markets work at times of peak uncertainty and the unpredictability of these gyrations is why we always say: ‘time in the market is better than timing the market.’

Here are a couple of other good reasons to stay invested:

  • A lot of bad news is now priced into the market. If things turn out to be better, or even no worse, then markets could rebound quickly. Many investments are oversold and cheap. In some cases, the question is binary - if a company survives, its value will rise sharply from here. By contrast, almost nothing is overvalued today.
  • Selling today is an easy decision; knowing when to buy back is much harder. You will almost certainly leave it too late. The best returns in the market cycle are made when things start to look just a bit less bleak.
Unprecedented volatility

Source: Refinitiv, as at 31.3.20. Daily percentage change for S&P 500

Past performance is not a reliable indicator of future returns. 

% (as at 31 Mar) 2015-16 2016-17 2017-18 2018-19 2019-20
S&P 500 8.1 17.2 14.0 9.5 -7.0

Past performance is not a reliable indicator of future returns
Source: Refinitiv, as at 31.3.20

Fund recommendations

Finally, I’d like to revisit the fund recommendations I made at the beginning of the year. I said I would do this every quarter, and no-one would be impressed if I only did so when the picture is prettier than it is today. First, let’s remember what the world looked like in December. The expectation was that lower interest rates and a cessation of hostilities in the trade war would allow earnings to continue growing in 2020 as recession was pushed back by another year at least.

Of course, the world has changed completely since then but my thinking hasn’t altered much. I was cautiously optimistic three months ago, conscious that after a very strong 2019 markets might give something back. For that reason, I stuck to two defensive fund choices from last year, Fidelity Global Dividend and Fidelity Select 50 Balanced. My new picks were in markets which I thought had potential to return to favour, Liontrust UK Growth and Artemis Global Emerging Markets.

The two defensive picks have done what I would have hoped, falling much less than global markets as a whole. The UK  and emerging markets funds have been broadly in line with their respective benchmarks.

It is early days. What is more important is that I remain convinced by all four funds and have invested in all of them personally.

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