What today's unprecedented economic and market conditions mean for investors in markets around the globe.
Healthcare Security Tracking: New COVID-19 Cases
We are looking to see a plateau and then a decline in new cases, because that would be the indicator that we are gaining control over COVID-19 and a turning point for countries to start to re-energise their economies.
The below chart from the European Centre for Disease Prevention and Control1 shows how these numbers have been progressing daily worldwide from January 1 to March 31st, 2020, by region. The number of new daily COVID-19 cases worldwide continues to increase steadily in every region. On March 31st, 2020, Europe reported 31,199 new cases. North America reported 23,028.
Number of new daily cases of COVID-19 globally
Source: Statista, January 1, 2020 – March 31, 2020.
Economic Activity (Kim Catechis, Head of Investment Strategy)
The number of confirmed COVID-19 cases in the United States is at 189,633 at the time of writing and still growing, with the states of New York and New Jersey accounting for over 94,528 cases between them. Congress and the Senate approved a significant package ($2 trillion), of which large sections are aimed at the unemployed – meanwhile jobless claims came in at 3.3 million – a historic high. The previous high was 957,000 in January 2009. Industrial activity indicators are not yet showing the signs of the contraction that the regional fed surveys suggest, but the early releases indicate that consumer sales (excluding autos and fuel) are around-10% below normal levels. In total, the Federal Reserve assets have grown by $944bn in the last two weeks.
China’s Purchasing Managers Index (PMI) surprised on the upside with a 52 reading, after February’s historic low of 35.7, suggesting a significant bounce back. Bearing in mind that one month’s numbers do not necessarily mark a sustainable trend, the scale of the jump is impressive. For Q1, the market expects a significant negative print, with a rebound in Q2/Q3. For now, it seems that consumption is back to around 85% of normal (excluding autos and property) and port activity is back to normal.
In Japan the government is signalling a stimulus package of around Y60 trillion2, which would exceed the 2008 version of Y57trn.
Big Picture analysis (Reece Birtles, Martin Currie Australia's Chief Investment Officer)
COVID-19 has created a difficult situation for people, markets and economies. We are used to seeing financial markets being very reactive, driven by emotions such as euphoria, fear and pessimism, but the real economy doesn’t usually react this way, even during the last big crisis, the GFC, where nominal GDP growth in Australia continued throughout.
This crisis is not like the GFC, this time we expect nominal GDP will fall significantly. The political and social response to COVID-19 has exacerbated the tendency to overreact and extrapolate inaccurate variables and assumptions such as the success of Social Distancing, hospitalisation rates, fatalities, contagious periods has caused the emotional reactions that are normally confined to markets to spread to the real world.
As a result, this crisis has created a very different scenario for company profits. Martin Currie Australia have a Profit Pulse Indicator that looks at several top-down factors to predict earnings growth. These include consumer confidence, lending growth, the Australian dollar, terms of trade etc. The Profit Pulse Indicator suggests that the market earnings growth for Australia will be very negative through to June 2020, in the order of -40%. Broker consensus earnings growth data has not reacted much to this change yet, but it is normal in these environments for earnings forecasts to lag a changing real world
But what is interesting when comparing to the GFC, is the nature of the stress that makes up the Indicator. During the GFC, banks were short of money, capital and liquidity. Companies had been over leveraged, building business models based on excessive levels of demand and extra supply. Banks didn’t have the capital to help businesses refinance, so deleveraging balance sheets was the main action.
COVID-19 is different situation because instead of a liquidity problem, revenue has just completely disappeared due to Social Distancing. Profits have gone to zero, or for example in the travel industry, free cash flow is negative. The situation is about now more about finding the liquidity to fund operations while the stand still continues. While there will be far more forgiveness from Government and they are also encouraging the banks to be more forgiving, reducing social interactions means stopping a lot of economic activity, and how long the holdup continues will depend on all of us playing our part.
As Kim mentioned above, news this week was that the PMI of China has gone back to a level of over 50, despite the previous read showing a large contraction. This indicates that things are getting back to normal there, at least for much of the country. The lagged read through for Global PMI ex China will be that it most definitely will contract significantly in coming quarter. But we expect to see a very weak June quarter, but then an improving September and a more normal December quarter as we get the spread under control.
Outlook & Investment Strategy
Kim Catechis Head of Investment Strategy
The range and breadth of relief packages announced in the last two weeks is impressive, totalling around 2.6% of global GDP at the time of writing. This represents a significant uplift to the 1.6% of global GDP deployed during the GFC in 2008-09. One of the characteristics that is different this time around is a focus on ‘Main Street’ over ‘Wall Street’, to compensate citizens and small and medium businesses, who are the backbone of the economy.
However, the inevitable impact is the deterioration of sovereign balance sheets in the short term and the ratings agencies have clicked into gear. The UK was downgraded to AA- by Fitch on the 27th March, South Africa by Moody’s, losing its investment grade status on the same day. Mexico was downgraded by S&P the previous day, as was Kuwait, also by S&P.
Clearly there will be others over the coming months and although the rationale is inescapably justified, there will be a series of structural knock on effects for companies, which investors would do well to remember.
Reece Birtles CIO Martin Currie Australia
On a market aggregate level, we may have already seen the bottom, and this has occurred a lot earlier than during the GFC which took almost 2 years (July 2007 to March 2009). Global and Australian share prices have already fallen to a similar level to what would be expected when the earnings hits from next 3-6 months shutdown flow through consensus numbers.
But it will still be a bumpy ride from here. We don’t expect that the Government will be releasing the Social Distancing measures any time soon (despite some indications of curve flattening in Australia) and we need to be conscious of a potential second wave of cases.
But the experience through this will not be the same for all companies. Stock specific issues can be expected, and there will be greater divergence across the market as participants start to focus on genuine company fundamentals once more.
We will see earnings and dividends trending down over next 6 months across market, but not all companies are equal. Some will be more defensive in ability to continue to pay dividends in this environment.
We will see companies run out of money. Debt will rise due to negative cashflow. We expect that banks will extend debt to companies where their resulting debt ratios look reasonable when normal earnings return, but not to those that debt levels will get out of hand. That’s where we will see rights issues.
We are continuing to look for companies that will be stronger on the other side, investing in attractively value names have only short term COVID-19 impacts, rather than those using as an excuse for underlying earnings problems.
We are now at the stage where we are looking for opportunities that come out of this environment. Given how quickly it’s all happened, a lot of market pricing has been driven by investor needs such as liquidity, cash flows and portfolio rebalancing, rather than company fundamentals. Active stock picking opportunities will come from finding the right names over the coming months as reality kicks in.
1 Source: Statistia, @ECDC [205-2019] https://www.ecdc.europa.eu/en/publications-data/download-todays-data-geographic-distribution-covid19-cases-worldwide
2 Source: Reuters, https://www.reuters.com/article/us-health-coronavirus-japan-stimulus/japan-plans-huge-stimulus-package-to-cushion-blow-from-coronavirusidUSKBN21E0UW
COVID-19 is the World Health Organization's official designation of the current coronavirus disease.
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