Weekly Update: COVID-19

Weekly Update: COVID-19

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, hospitalization 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.


Footnotes:

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

Definitions:

COVID-19 is the World Health Organization's official designation of the current coronavirus disease.

A credit rating is a measure of an issuer’s ability to repay interest and principal in a timely manner. The credit ratings provided by Standard and Poor’s, Moody’s Investors Service and/or Fitch Ratings, Ltd. typically range from AAA (highest) to D (lowest). Please see www.standardandpoors.com, www.moodys.com, or www.fitchratings.com for details.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Fitch Ratings is a global rating agency committed to providing the world’s credit markets with independent and prospective credit opinions, research, and data.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

The Great Financial Crisis (GFC), also known as the Great Recession, the financial crisis of 2007–08, global financial crisis and the 2008 financial crisis, was a severe worldwide economic crisis considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s, to which it is often compared.

Growth refers to stocks of companies whose earnings are expected to grow at an above-average rate relative to the market. A growth stock usually does not pay a dividend, as the company would prefer to reinvest retained earnings in capital projects.

The Martin Currie Australia (MCA) Profit Pulse Indicator looks at several top-down factors to predict earnings growth, including consumer confidence, lending growth, the Australian dollar and terms of trade.

Moody's Investors Service is a leading provider of credit ratings, research, and risk analysis.

Purchasing Managers Indexes (PMI) measure the manufacturing and services sectors in an economy, based on survey data collected from a representative panel of manufacturing and services firms. PMI greater than 50 indicated economic expansion; below 50, contraction.

Social distancing is deliberately increasing the physical space between people to avoid spreading illness.

Standard & Poor's (S&P) is an American financial services company that publishes financial research and analysis on stocks and bonds and is also known for its stock market indices such as the U.S.-based S&P 500.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH. Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

The aforementioned Legg Mason entities are wholly owned subsidiaries of Franklin Resources, Inc.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.