Special Market Update

What has happened?

As many of you would have been following, investment markets locally and globally have fallen sharply this week on renewed concerns regarding the Coronavirus, or Covid-19, as it’s known.

At the time of writing, both the Australian and US equity markets are down more than 8% for the week, with Europe down more than 6%, and Japan down more than 5%. US technology stocks are down almost 8%.

Why has it happened?

Up until the end of last week, investors had largely ignored the Coronavirus on the basis that:

1. The significant Chinese response in dealing with the spread of the virus (some 500m people and some 100m students stuck at home) had been enough
2. The decline in the reported number of new cases and deaths, which would point to a peak in the virus occurring over the next week or so
3. The significant response by the Chinese authorities on the fiscal and monetary stimulus front
4. The understanding that economic growth and corporate earnings in the short term would be hit, but that this would be rather temporary in light of a better than expected 4^th quarter reporting season from corporates.
5. That governments and central banks both locally and globally would provide stimulus if required – which they now have.

That was all forgotten over the weekend as we saw a sharp rise in reported Coronavirus cases in South Korea, Iran, and Italy, largely due to lax preparedness and protocols from those countries or the complacency that China had already contained it.

This has resulted in the use and reference of words like “pandemic” based on the technical definition of disease existing on more than 2 continents. News headlines have done a spectacular job at making sure that the word pandemic is fixed in our short-term memory for now.

What do we know?

At the time of writing, we know the following:

1. There has been more than 82,000 cases of the virus globally and more than 2,800 deaths
2. More than 33,000 people have recovered
3. There are more than 46,000 active cases with 82% in a “mild” condition and 18% serious or critical
4. Of the more than 82,000 cases, more than 78,000 have occurred in China. The rest of the world spread is as follows (with deaths in brackets):
5. South Korea – 1,766 (13)
6. Italy – 655 (17)
7. Iran – 245 (26)
8. Japan – 207 (4)
9. Singapore – 96 (0)
10. Hong Kong – 92 (2)
11. USA – 60
12. Range of other countries – 252 (3)
13. Australia – 23 (0)
14. Incubation period is 2-14 days, with an average of 5 days. There are some reports of “super carriers” who could have an incubation period of up to 27 days, but these are few and far between
15. The transmission rate is 2-3 people for every 1 person infected. For SARS, it was 2 and for the common flu it’s 1.3.
16. Overall, the rate of growth in the total number of cases and deaths is slowing

From a non-medical perspective, we know that local and global economic growth will take a hit in the short term as will corporate earnings in light of the response from governments and corporates to shut down cities and ports, restrict travel, and enact significant quarantine protocols.

Is the market reaction this week an overreaction or is there more to come?

This is difficult to say.

Considering markets paid little to no attention to the virus until this weekend, you could argue that the virus is a lot worse than we think/know and that the falls this week were necessary to temper the gains in the market since the beginning of 2020.

In contrast, you could argue that the sell-off this week is a mass overreaction given recent corporate earnings reports had been stronger than expected, central bank cash rates remain at very low levels whilst central bank balance sheets remain bloated (money printing), central banks remain ready to provide more stimulus in the short term if required, and recent political risks (US-Iran, US-China, UK-Europe) had subsided.

From a structural perspective, a significant amount of daily trading activity is now done by algorithmic / ETF / quantitative (computer) trading, with only a small proportion done by discretionary traders. This means that markets tend to be more momentum driven than ever before, both upwards and downwards, which exacerbates the short term peaks and troughs in markets.

Should investors be overly concerned?

The short answer is NO, especially for those with a long term investment horizon (all of our clients).

Underlying conditions still remain very supportive of equity markets pushing higher over the medium term. Given yields on cash and bonds remain extremely low, investors won’t want to sit in low yield assets for too long. For example, the most recent sell-off we had in equity markets occurred in the 4^th quarter of 2018. By the week of Christmas, the P/E ratio on the US equity market had fallen to 14 times, and investors swiftly saw value against very low yields on cash and bonds, which preceded the spectacular returns we saw in 2019.

We think a similar response is possible in the near term, which could be further supported by a local and global fiscal (government) and monetary (central bank) response. Once investors find value, the significant sums of money sitting in cash and bonds globally will rotate back into equities. However, investors may take a little longer than expected to get settled given the very fluid situation when it comes to a virus.

What should I do?

On the health front, we can’t stress enough the importance of personal hygiene. Take care of yourself and the others around you.

On the investment front, during these times of volatility, we should remind ourselves of the following:

• As part of a long term investment strategy, it is important to stay the course. Crystallising a loss of more than 8% in the short term never makes sense.
• Your portfolio is diversified across asset classes, which can include equities in Australia and globally but also with allocations to property, fixed interest and cash. When you see headlines stating the falls of a particular share market, this is relevant to the index of that particular share market only.
• ‘Active’ fund managers actively trade holdings based on their views. They have more ability to provide outperformance during periods of volatility. They can often take an opportunity like this to allocate to a stock they like, but have previously not invested into due to a high price.
• If you are not invested in markets or have surplus cash and are thinking about investing – swift sell-offs like this week largely always provide a good opportunity to deploy cash to get into markets at lower values.  However, this decision is largely a function of your risk tolerance and your time horizon and we would recommend you seek advice.
• Reduce the “noise” by reading less of the sensationalist headlines and stories that “news sources” profit from.
• It is not possible to time markets and often the best returns follow the worst returns. As outlined in the image below, being fully invested over the 22 year period to 2018 has provided a good return; which is significantly reduced if some of the ‘best days’ are missed.

• There have been multiple outbreaks and epidemics over recent history and markets have provided a positive long term return despite these.

Financial Keys continues to monitor market developments. If you would like to discuss your particular portfolio or investment strategy please don’t hesitate to contact us.

Mark, Brendan and Matt