We are writing this early Monday, with markets down substantially.
We take the view that these are the times when clients need to hear from us with hopefully good information and considered analysis of the causes and effects of the events taking place. We have no expectation of being right, but it will be less hysterical than anything from global media and will focus on far longer time horizons than the next day or week.
The market fall today is a further replay of two weeks ago, when the Coronavirus became a financial issue (last week was broadly flat for markets even though there were big swings up and down).
So, what has changed?
- The virus is now in Europe and especially prevalent in Italy, where quarantines now exist in large parts of the north of the country. This is an ongoing event and not the main catalyst for today’s volatility.
- The oil price has cratered today mainly due to the failure of Saudi Arabia, the defacto head of OPEC and Russia, the major element of OPEC Plus, to agree supply cuts. Russia has both a much lower production cost, so is less concerned about price and a love of leveraging dislocation, to create conflict and discord as opportunity presents. The Saudis have decided to respond to Russia’s breach of coordinated action by announcing they will flood the market with additional supply. This is therefore a straightforward case of two of the big boys having a ‘face off’ and doing so at the most inappropriate moment possible.
Markets which are jittery and unsure already about how to price assets with COVID-19 have just been thrown a new and unexpected curve ball. As they do when they don’t know what to think, they panic, sell and then consider.
It’s the perfect storm of a simultaneous oil demand and supply shock, on top of the existing concerns about supply and demand dynamics generally in global trade.
So why can we be medium term positive?
- I was initially puzzled and slightly unnerved by the dichotomy between my understanding of the danger to life of the virus being real but not overly serious, compared to previous health scares and the dramatic and unprecedented global governmental response. If this is ‘just’ a nasty flu, why act so strongly? Is it actually far worse than I realise? The reality of why became clearer as I came to understand the implications on healthcare infrastructure and why therefore the pressing need to slow down transmissions. Simply put, no healthcare system will cope with massive infection over a short period. The result is a complete overwhelm to intensive care provision. So, the Governmental game plan if viewed from this perspective is to slow transmission, not have overwhelm to health services and allow the warmer weather in spring/summer to act as the natural break to the virus (assuming it acts as a flu virus behaves, which is to become mostly dormant in warmer weather). This does not mitigate the reality of the risks to health or to economic activity, but it explains Governmental shock and awe tactics and takes away, I think, the anxiety of far greater severity. We have experienced a number of previous outbreaks of flu variants (Avian and Swine) and they have passed.
- The economic effects of the disruptions to global supply chains are real, as are the oncoming falls in global economic growth but they are transitory and the majority of what is lost now will be made up later. The areas of markets which will escape any lasting damage are the sectors where we already invest such as technology, healthcare and biotechnology. The case can be made in fact for the virus acting as a catalyst for a greater and more rapid adoption of technology to work remotely and for remote interactions with medical provision and supply which were trending up anyway.
- The Governmental response to the global economic disruption will be two-fold. The Central banks will cut rates (US already down 0.5%) which will, as panic abates, push more money out of cash and into risk assets. If one looks at the yields though on say US Treasuries, they are currently down well below 1% with Germany actually negative, so once the panic subsides where is money going to flow? Safe, strong multinational corporate share dividends are above 3% currently and high quality Commercial Real Estate companies are yielding 5% and above, whilst trading at discounts to the Net Asset Value. The second response will be for Governments to take advantage of being able to issue almost zero interest debt and invest into infrastructure projects which is known as Fiscal stimulus. This has been needed for years but is difficult for governments to engage with in size because it increases debt levels. They will do it now and it will be stimulative to growth.
- Just last week, Joe Biden staged a recovery to shame Lazarus, by winning ten Super Tuesday primaries and surging ahead of Bernie Sanders for the Democratic nomination. This is massively good news for markets. In the year end review, I talked about the risks associated to Elizabeth Warren as a candidate but Bernie, who is cut from the same ideological cloth as she is, was equally as concerning. In benign times people can comfortably engage in flights of economic/social restructure dreaming. They will however, get much more pragmatic in times of anxiety, hence Uncle Joe’s Phoenix from the ashes’ resurgence. I don’t think markets will care greatly if he or Donald prevail in November, The Big D is more stock market focused but he’s also a wild card, so it broadly evens itself out.
The illusion of certainty
I can go all ‘esoteric’ on you and start waffling on about the complete lack of certainty to our existence and the illusion of comfort we derive from doggedly believing the opposite. But this is best illustrated with a simple bit of maths.
If you take a 30-year US Treasury yield which let’s say is currently paying 1% and compare this to a share in a company like Johnson and Johnson, which is Triple A rated.
So, a 30-year Treasury is effectively buying a share in USA PLC which pays 1% each year with no capital growth. If inflation averages 2% p.a. for the next 30 years, then the return of the original capital at the end, even after the income, will have a real value of around half the initial amount invested.
A share in J&J which is global healthcare company, paying a dividend currently of around 3%, which increases every year. In addition, the company is growing profits by let’s say 5-7% each year for the next 30 years, as it has for the last 50 years or so.
If an investor makes a 1% real return after inflation on the dividend, plus capital growth over 30 years at 5% compounded, this turns the original £10000 Invested into £40000 (hypothetically).
Now that’s not a certain outcome, but it’s mathematically a conservative estimate of the probable outcome.
Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.