2019 was an unusually strong year for returns with risk assets such as equities and defensive assets such as government bonds both delivering returns well above their long-run averages.
We began 2020 thinking a share market correction was likely in the short term but couldn’t think of a catalyst. Central banks had been keeping interest rates low and the global economy seemed to be at a gentle turning point. Tension in geopolitical issues such as US-Iran relations, Brexit and the US-China trade war had all eased.
Then on 31 December 2019, China began reporting cases of a new COVID-19 virus (coronavirus) that began in Wuhan, Hubei Province. The share market shrugged off these early reports and continued to rally during January and the first three weeks of February as the virus spread, making an already over-valued market even more over-valued.
The world has seen many epidemics in the past and they tend to be short-lived, particularly those seen during this millennium (Severe Acute Respiratory Syndrome [SARS], Middle East Respiratory Syndrome [MERS], Swine Flu and Ebola) due to advances in treatment and vaccine development. These lessons learnt and the improving data probably goes some way to explain why equities initially rallied through January and into February as the virus spread. However, the rapid spread of the virus and the restrictions imposed by government on travel and public gatherings are now impacting a wide range of industries across the globe.
Warning signs were apparent during the second week of company earnings updates (Reporting Season) in Australia when the number of management teams mentioning the risks from the virus outbreak rose. Travel and tourism industries have been impacted, and with China being a manufacturing hub, the closure of cities and factories has hit global supply chains hard, restricting business activity. Another sign that global demand has weakened can be seen in the collapse of the oil price – since the start of the year prices have fallen by around 50%.
Travel and crowd gatherings around the world have been restricted. Supply chains have also been blocked affecting manufacturing of consumer and industrial goods and this could easily feed into rising unemployment.
All of the economic uncertainty has led markets to endure some of their worst performances since the Global Financial Crisis (GFC).
Reaction by policymakers
Confidence is a vital component of economic behaviour that underpins financial markets and investor returns. It can be won over time, but it can also evaporate rapidly.
Confidence has collapsed as it did in the 2008 GFC and central banks have moved swiftly. In Australia, the Reserve Bank of Australia (RBA) reduced interest rates to provide support to economic activity and Australian Prime Minister Scott Morrison announced a $17.6 billion support package on 13 March. The package is designed to prop up the economy and Mr Morrison has not ruled out more economic stimulus ahead.
The US Federal Reserve (the Fed) decided to cut their main interest rate to near zero and begin buying government bonds to add money directly into the economy in a dramatic shift in policy settings. President Donald Trump is also deploying stimulus packages to stave off recession, but the market doesn’t seem convinced it is large enough or being rolled out rapidly enough. Several European countries and the UK have also implemented stimulus packages.
Where to from here?
News of a slowdown in the spread of the virus or the development of a vaccine would provide a timely shot in the arm for share markets even though both of these developments don’t seem likely in the near term.
It is likely we will see a recession (defined as two consecutive quarters of decline in economic growth) unfold in the coming months.
Effective diversification is important, particularly in this environment. While investments in one part of a portfolio may suffer losses, other investments may remain stable or even increase in value. Our lifestage and diversified portfolios use a mix of different asset classes so that there’s a layer of protection from downturns and gains once the share market rallies again.
While the news headlines make it hard not to feel panicked, it’s important to take a calm and considered approach. A long-term focus is critical during times of market turbulence and history has shown that markets have the ability to recover from significant downturns. So while the coronavirus is clearly impacting the global economy now, we will likely see a recovery in the medium term.