Almost two months into 2020 and we are definitely living in interesting times…
The bushfires in December and January and the heavy rains and storms in late January and February remind us that ‘our wide brown land’ will always provide challenges.
This year we also have the ‘Coronavirus’ and we need to talk about it as it does have some investment implications and that is not to try to understate the human tragedy.
The investment markets have performed well above our expectations over the last 14 months and that has been a very good thing. We have continued to rebalance quarterly and take profits and this is done as a discipline so as not to fall in love with our own narrative.
This means profits were taken from International and Australian Equities on 31 December 2019 and moved to more defensive assets. The markets were then very positive in January and early February but we have given a lot of the last two months gains back over the last few days.
Firstly the catalyst for the market volatility.
The Corona virus has spread which means it will likely be called a PANDEMIC. Sounds really bad. An epidemic is a new disease that breaks out in a region. If that spreads to other countries (Corona virus is now in 29 countries) it becomes a pandemic.
The last pandemic we had was in 2009. It was a new strain of influenza which may have infected up to 1 billion people in the first six months. (Hard to know the actual number but it was a lot). It is believed to have killed hundreds of thousands in its first twelve months. Corona virus was identified in December 2019 and at the time of writing this paper (2020, February 26) approximately 2,700 people have died from it. It has not been called a ‘pandemic’ by the World Health Organisation, as yet, as “we are not witnessing the uncontained global spread of this virus, and we are not witnessing large scale death or disease” (WHO Director-General, Tedros Adhanom Ghebreyesus, Feb 24). I think that was supposed to be reassuring?
In Australia at 6.30am, 26 February 2020, we have 23 confirmed cases. 8 in Qld, 4 in NSW, 7 in Victoria, 3 in SA and 1 in WA. (https://www.health.gov.au/news/health-alerts/novel-coronavirus-2019-ncov-health-alert)
15 of these cases have been reported as recovered and the remaining 8 are in stable condition. 8 of these cases were on the Diamond Princess repatriation flight from Japan and were diagnosed when they got to Darwin.
Around the world at 26 February 2020 there have been over 80,400 confirmed cases and the case fatality rate in countries and regions outside mainland China is 1.4%.
This has become a big part of the news cycle, which is good as we are all taking precautions, but it also can lead to some hysteria.
This hysteria can then translate to investment markets as traders start looking for opportunities and risks. We can all make some pretty simple assumptions. International travel will be down – not great for planes, hotel chains and airports as well as all the ancillary services like ground transport, cafes, restaurants, etc. As a tourist destination, the Gold Coast will definitely feel this.
Foreign students make up a large part of our student base so this will impact services on campuses, however these students are still enrolled so not necessarily a huge impact on university and school fees.
A large portion of our imports come out of Asia and China provides manufactured goods to our suppliers in Asia. China mandated that its factories closed and were not to reopen until 9 February, and many have still not opened as at 23 February.
Picture a manufactured good that needs at least one component part from China. When those components run out, nothing will get finished, until the Chinese suppliers reopen or they find alternative sources.
There are flow on effects all around the world and that is the concern. If companies can’t sell anything, earnings will be down and so will profits. Workers will not receive wages, they won’t have money to spend which will impact small businesses and on this goes.
Have I got you really worried yet? The more you think about it, the worse it can seem.
It will definitely impact earnings in 2020. Good quality stocks with strong balance sheets will still be hurt and this will be reflected in their prices. Australian company’s balance sheets are generally far stronger than they were before the GFC. US companies, on the other hand, are actually more highly leveraged as they have followed the growth of their market up using cheap credit to boost returns and buy back equities.
We can expect markets to stay volatile until there is some certainty. Listening to expert analysis, a vaccine, when it is created, will still need to go through animal trials, then human trials and then we will need to synthesise over a billion doses and distribute it.
In the meantime, life will find its new normal.
People will go to work, factories will reopen, people will still buy groceries, build things, replace goods and take holidays. We will still export minerals and agricultural products. Our banks will still lend and fund housing growth and yes, we will still have immigration.
Warren Buffet was asked what he thought and his answer was pretty simple – I am paraphrasing here. Good companies will still do better than bad companies and good companies will do well in the coming years – maybe just not as well this year.
This does not mean we should not pay attention and take opportunities as they arise.
Valuations have been stretched and this period could see some great buying opportunities. Troy and I spent the last two days (Monday and Tuesday) in Sydney and had 12 presentations from different managers within our models. The more conservative managers are already holding cash after taking profits. One Australian equity manager has 16% ready to invest as he sees value return to the market.
Our International active managers have had an extraordinary year and have been struggling to find reasonably priced good quality stocks in the past six months. They didn’t see the Coronavirus coming but they were wary that the market would overreact to a ‘Grey Swan’ event of some sort.
As with the last quarter of 2018, many of the moves you are thinking about have been done. Cash has been increased, profits taken and defensive assets rebalanced. Clients in pension phase have cash reserves to carry them through this volatile period without crystallising any losses.
The ‘news’ will be negative for some time and this will cause volatility. Volatility can be good.
We, and the managers we utilise, are cautious. It will be an uncertain period but as in previous years, markets could surprise us.
As always, if you have any concerns, please talk to us. There are things we can do to reduce risk, if that is a priority.