Way back in October 2011 I penned the following piece in The View as world share markets entered bear market territory.
The crisis had commenced in August when the US lost its AAA credit rating (and has not recovered it since) and world capital markets were in turmoil and seemingly heading into a “Greek default” induced calamity. Many commentators at that time were suggesting that investors sell out of the equity market with the GFC still clearly in people’s memories.
The parallels with today’s headlines in the mainstream press are clear to see. The current equity market correction, driven by the coronavirus, Covid-19, has given rise to the rerun of classic headlines like “Billions wiped off equity markets”, “blood in the gutters” and the well-worn “Panic selling by investors”. The utilisation of the description “investors” rather than “speculators” gives the impression that rational people are frantically giving up their long held investments and therefore you should too!
Source: Financial Times, Refinitiv
The disruption caused by the coronavirus is indeed concerning and not to be dismissed as an aberration. It will result in world economic data for (at least) the first quarter of 2020 being very weak.
Concerns that major events could soon be cancelled (think of the Olympics due to commence in Tokyo on July 24), that international tourists are cancelling trips, that manufacturing supply lines are becoming frozen, etc, are all true and they paint a difficult short term outlook.
However, whilst I will not claim that there is never a good time to sell equities and reallocate to other asset classes, I will categorically state that there is never a good time to panic and sell equities.
Equities (and never more so then today) offer exposure for investors to benefit from the world growth emanating from the two major structural cycles at present.
The first cycle is haphazard but does exist. It is the long growth cycle of the “developed world” as it drifts in and out of mild growth slowed by aging populations but benefitting from trade with the “developing world”
The second concurrent and more powerful is the “developing world” growth cycle. In this cycle, which will endure for many more decades, hundreds of millions of people will steadily emerge from poverty into a better quality of life. This second cycle is propelled by urbanisation and technological developments, and it will periodically be checked by short-cycle downturns.
The developing world growth cycle will continue to drive the developed world cycle, so that total world growth continues to grow as it always has.
Clearly the coronavirus is a serious and developing problem for short term world growth as it will check both trade and the movement of people. However, it is very likely that it will be contained, managed and ultimately defeated, as has every other confronting virus in the past, including influenza, measles, Aids, SARS, Ebola, Zika virus and many others.
If the world does not defeat the virus, then all thought processes regarding investing for the future will become irrelevant. We should all go home and spend what time we have left with our loved ones.
Source: Financial Times
Some speculation of what may happen in coming weeks or months
As always, I believe the shorter term is harder to predict than the longer term, and more so when forecasting market movements and human behaviour.
However, observations of the past, particularly the last ten years, give us clues as to what the global central banks will likely do if emotion and hysteria appear to be dominating markets.
Clearly the world’s major central banks will want to avoid a market meltdown that will in turn lead to an economic meltdown. The central bankers have not spent ten long years in printing money and manipulating interest rates that kept oxygen flowing to markets to suddenly give up and watch equity markets collapse.
If central bankers have been prepared to buy government bonds, corporate debt, mortgage-backed securities and property securities (as in Japan), why would they decide that equities are a no-go zone?
Source: Financial Times
However, before central bankers intervene, they probably would regard the deflation of excessive valuations in some equity markets as desirable. A “healthy correction” may well be the collective view of central bankers, whom should be equally concerned with the excesses and illogic of major bond markets.
Whilst central bankers have caused the bond market bubble they must surely be surprised (if not bemused) that that some bond yields continue to drive deeper into negative yields. For instance, German thirty year bonds once again went into negative yield territory as coronavirus hysteria took hold this week.
In terms of the financial health of an investor, I wonder whether they would suffer more financial risk from contracting the coronavirus or from being invested in a negative yielding bond for ten or twenty or thirty years?
Clearly as bond yields move lower, well below inflation and in some instances further into negative territory, the relative value of equities, given the long term growth trajectory of the world, becomes obvious.
Most important in periods of panic is the understanding that equities are perpetual investments. Good quality equities will return to growth after a setback. They will recover and recommence to generate profit and cashflow. They will return to paying and growing dividends. Compare this to a negative yielding bond that is not perpetual and has a return profile that if held to that maturity that is negative!
Markets are driven by the sentiment of people buying and selling, and they (or we) are fickle much of the time. We become more desperate and terrified as prices fall, and happy through to ecstatic as prices rise.
The central bankers know this and will exploit this at some critical point in the future. They have proven for almost a decade that even the smartest money or asset managers can be convinced by various means that negative yielding bonds are a desirable investment for their clients.
Also, fiscal policy will swing into action and governments will use tax changes and monetary payments to stimulate consumers and businesses.
For instance, this week the Hong Kong government declared that all adult permanent residents in Hong Kong will receive HK$10,000 (A$1,950) and companies will receive a guarantee on loans taken out to pay wages and taxes – part of HK$700m boost by the government to support the territory hit by coronavirus and political unrest. This is an example of “helicopter money” and it was previously used in Australia by the Rudd Government during the GFC.
Source: Zero Hedge
In Australia we note that the Government has relented on its promise to produce a budget surplus in FY20. We predict that if the coronavirus continues to affect the Australian economy into the June quarter that substantial tax payment relief will be given to small and mid-sized businesses. This would help business cashflows at a time when stock levels are falling, or consumer sentiment is challenged.
There is much that can be done by sensible fiscal governance and there is little that the RBA through monetary policy can do other than ensure liquidity is plentiful in financial market and that banks do not restrict essential credit.
It will be an interesting few weeks and possibly months for markets. The coronavirus, the US election and the US China trade deal are amongst many other unknowns, but the likely behaviour or responses of central banks and governments is more predictable.
Is that a reason to be bullish in the short term? No. But it is a reason to remain calm, not panic and invest logically at a time when markets are being driven by wild speculation. The long term outlook for world growth looks good and that is what investors (not speculators) need to focus upon.