March 13th, 2020
Coronavirus Update #1
Written by Square Mile Investment Services.
Yesterday, global stock markets endured their worst trading day since the 1987 crash. The FTSE 100 fell by 10% and the index has slumped by over 31% so far this year. Is this as bad as 2008? Certainly, the speed of the market adjustment is beginning to feel like the nadir of that crisis. However, in distance travelled global markets are only off 20 to 30% compared to the 40 to 45% falls in ’08. What is very different is that the financial system is not at risk. The main costs of this outbreak will fall upon governments, business will face a period of disruption. The key question is how long this period of disruption will last and markets are likely to become more settled once this is determined.
We take much from the Prime Minister’s statement yesterday. Action against the outbreak is being moved to one of managing and slowing rather than elimination. Isolating and suppressing outbreaks involves very significant economic costs that largely fall on businesses. Managing and mitigating will also have costs, but these will be largely borne by what is likely to be recognised as the heroic efforts of our health service. Businesses will be impacted, and a recession is probably already underway. However, the odds of the worst-case scenario for the economy, that is repeated attempts to isolate the virus around the world, are rapidly receding. As yet, this is yet to be accepted by the WHO and President Trump, but we are now assuming they will soon be obliged to.
This disease will kill many. Many experts estimate that the fatality rate will be around 2%. I am not usually an optimist, but I have reasons to hope that it will turn out to be below this. Death rates in places like Italy appear alarmingly high but the average age of the fatalities is over 80 years. This is a disease that hits the old and those with chronic health problems hardest. Thankfully, infants will be very largely spared. The majority of those infected, even those in the most vulnerable groups will fully recover. However, it will place enormous strains on health services as this plays out.
As the authorities begin to accept that the disease cannot be contained, it provides markets with greater clarity that the effects on the economy will be short term. Certain industries will be hit hard such as in the travel and leisure sector. It may make sense for governments to help support these during this period, just as the banking sector was aided in the financial crisis. We also need to consider how economies might be stimulated back to growth with interest rates already at essentially zero. We believe that policymakers still have options to attempt this.
We know the economy is in the process of taking a big hit. We feel reasonably confident that the worst economic effects will be transitory (weeks and months but not years). Bond markets are now signalling that cash rates will be more or less zero indefinitely and that interest rate support for the economy is at its limit. Yet in comparison equities offer a generous dividend yield. Even the low pay-out S&P 500 is on a 2.5% yield, whereas the FTSE All-Share offers over 6.0%. Even if we factor in say a 20% reduction in dividends (which is extreme) the All Share yield looks good. We believe that this is not the moment to be making panicky sales from what are long term investments and as uncomfortable as it seems in the short term, be reassured that markets invariably recover from shocks such as these. Trying to call market bottoms during rapid sell off such as these is futile, but it is likely in a few years’ time that the current market level will be seen to have been an opportunity. We are convening a formal investment meeting on Monday to consider our options.
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