March 2020 ATP Market Commentary: Gone Viral
• COVID-19 and its spread has meant significant market declines at unprecedented speeds
• Circumstances are markedly different from 2008 – the banking system is not the epicentre
• The pace of government responses, not to mention size, are extraordinary and necessary
• Approximately 35 days after full lockdown, China’s factories are fired once more
• Multi-generational investing opportunities are being created
From the outset we just wanted to make mention of the fact that this must be the third iteration of the intended client updates. The pace of developments have meant each previous version, within a matter hours, seemed out of date – even just this weekend’s announcements from Germany brings reason to update our comments. Events are unfolding at an unprecedented clip, however, as we touch on later, reassuringly, so has the wave upon wave of historical responses from central banks and governments globally. We’ve tried to adopt a punchier format than usual and organise the update under a question and answer format that we feel are most relevant to client circumstances.
WHERE HAVE WE COME FROM?
The outsized response from financial markets in some ways are reflective of a stock market that was seriously overextended and therefore highly vulnerable to a serious setback. In December going into late January, we saw overwhelming levels of bullishness in markets, spurred in part by ‘zero cost’ trading services available in the US, in a price war between the discount brokerages all looking to secure the custom of the American retail investors. Such overconfidence normally takes months to unwind, however, as we stand, that has been achieved in weeks rather than months. Now whilst many of the historical comparables we seek to draw on, in our asset allocation decision making seem to have lost
relevance in many cases, yet when considering the last 100 years of stock market history, we’re at a point which would suggest a higher probability of a multi month rebound in share prices. In short, whilst Covid-19 has ravaged financial markets, markets were susceptible to the degree they were on a sugar rush high but have reached levels that have previously seen rebounds.
The following table shows a number of circumstances where the US stock market (S&P 500), has lost 30% percent, and then shows the performance thereafter. Not every scenario sees share prices higher a year out, but many do.
1918 SEEMS A BETTER REFERENCE POINT THAN 2008
Coronavirus and the economic shock it is causing seems more relatable to the flu pandemic of 1918 rather than the Global Financial Crisis of 2008. The GFC was a balance sheet recession – it was caused by an overblown housing sector that collapsed, which led to a run on confidence on the banks.
Housing is the biggest single component of consumer wealth, and so the slowdown was so structural in nature that it needed a long drawn out recovery period. In contrast, it is not the banking system, (which is much better capitalised and resilient 12 years after the crisis), which is a weak point in the system – instead, on this occasion, it will be more be acutely felt in the travel, tourism and retail sectors. That’s not to say that the implications aren’t difficult to stomach – the global travel and tourism sector accounts for 10% of the global workforce. Airlines, cruise liners, hotels and restaurants and their supply chains will continue to be under significant pressure in the coming weeks – likely the summer at least before things normalise. Banks are better capitalised than they were in 2008, they present less credit risk, the epicentre of this particular difficulty in elsewhere. Moreover, should the size and speed of government and fiscal responses continue to build unabated, we hope that this will reflect a severe, yet shorter tailed cyclical slowdown rather than the structural recession which played out in 2008.
Given the current circumstances, its understandable that markets do not turn around on a sixpence, but we should expect some response ultimately, given nearly 40bn USD per month is now being injected into the system in what is in effect QE4. In fact, that’s just in the US. Previously when QE stimulus programs have been announced, they have inevitably provided support for markets.
War footing: Disregarding deficits
Given that we have very little historical context to draw on in this regard, our view is that it is time to throw away the rulebook. Economic proposals that are now 7 days old seem a little timid, compared to where we seem to be going. We are very pleased to see how quickly policymakers have recognised ‘this time it actually is different’. “We have to be willing to accept fiscal deficits on the scale of 2009,” said Adair Turner, the former head of the UK’s Financial Services Authority, in the Financial Times.
Exceptional times, mean exceptional circumstances, and economist and policy makers are warming up to radical solutions. Central banks have turned the fire hose on full blast with a range of new
asset purchase programs, the question then it how to finance them. Under normal circumstances, a government would borrow to finance the range of measures being implemented. However, there is another means – a means whereby it simply prints money to finance it’s own spending.
This has been referred to as ‘monetary finance’ but more colloquially, has been referred to as ‘helicopter money’. In essence, this trying to be more surgical about transferring monies to the private sector, to reach the real economy, in a way that quantitative easing measures perhaps haven’t so far. It’s a simple premise at heart, put money directly into consumers hands who may have lost their jobs – a very targeted economic backstop.
Until now, there have been disciplines and controls in central banking , but now we are on a war footing, past taboos are being, and will continue to be broken. This has been very well demonstrated this weekend just past when Germany, the last bastion of fiscal discipline has announced a 368BN EUR program which will buy all sort of assets, including taking equity positions in companies where necessary. They have taken the view, that potentially inflationary consequences further down the line are very much a consequence worth taking on at this point in time.
WHAT IS ‘HELICOPTER MONEY’?
Inspired by the example of Hong Kong, (cash handouts of HK$10,000 to all permanent residents), US, UK and European economists and politicians are considering something similar.
In the past few days, policymakers have put forwards a raft of bold and substantial measures to tackle COVID-19 head on:
• Germany has set out it will underwrite businesses by way of loans and credit guarantees
provided with a 550bn EUR ‘bazooka’ to provide businesses unlimited cash.
• French premier Macron has declared war on the outbreak, publicly declaring no business in France will fall to the virus, offering 300bn EUR of state guarantees to SME’s.
• In the last few days US Senator Mitt Romney, suggested a handout of 1000 USD to every
American in the interests of increasing spending in the US economy. As of this weekend, this is now in Congress being weighed along with a 1trn USD stimulus program.
It was only weeks ago, the idea of ‘monetary finance’, or helicopter money was confined to academic circles. There has been much criticism that the quantitative easing programs globally have benefitted the few, not the many. Therefore, helicopter money seeks to address that by, in short being a direct transfer of funds from governments to consumers – an attempt to be more surgical in increasing consumer demand. We live in a world whereby trillions of dollars of stimulus have perhaps increased the prices of
certain stock market investments, but done little for ‘real economic activity’ or for that matter, create any inflation, which in moderation, can act as a lubricant to economic growth. Stimulus this time round will seek to target the consumer’s bank account directly.
As the economic impact of the COVID-19 outbreak becomes clearer in the coming weeks, the concept of helicopter money or direct handouts to the end consumer, will generate more and more headlines. Central banks have provided massive monetary stimulus in recent weeks, but lower interest rates can only do so much. What is needed to revive private consumption and global growth generally is he consumer to spend once more. Increasing fiscal stimulus measures of the magnitude required to address the economic impact of the pandemic will likely generate inflationary pressures that have been
absent without leave for so long, but that is a price worth paying and is still in the middle distance yet.
THE SILVER LINING
China is recovering. In fact, in conversations we have with our counterparts in South East Asia, many factories are running at full tilt 24/7 already. Regardless of whether many will question its data, last week Starbucks opened all of its coffee shops once more. That is ‘hard data’ that can’t be manipulated. China does benefit from an ability to govern and mandate citizen behaviour in a more authoritarian manner than perhaps more Western economies do. But we think the penny has dropped now globally – China went on lockdown, and extended the China Lunar holidays – and after a giant collective effort,
they are seeing the fruits of those actions. Within 40 days of lockdown, congestion started to pick up once more and daily life adopted a more normalised (and outside) reality. This weekend, Chinese citizens across the countries are outside once more, spending time in parks.
ASSET ALLOCATION CONSIDERATIONS
The speed of the correction in markets hasn’t been seen before – this seems to be outpacing 1929 even. The FTSE 100 has fallen 34% from 7550 in February to approximately 4985 as we stand three weeks into March. We are seeing daily records being set.
Portfolios have not escaped unscathed, although have fared much better than the broad equity markets. Even what are considered ‘safe havens’, being government bonds have not escaped the selling as investors have sought to raise cash wherever possible. Throughout the first weeks of the sell off, we used a range of hedging techniques, such as investing in the US Dollar, gold along with positions and insurance policies that can benefit from falling markets. Admittedly, across our funds, as readings in certain indicators saw some of the extremes that were registered in 2008, we did put some cash to
work and remove some of the defensive measures we have invested into.
This was perhaps a little premature, as incredibly, some of the extreme readings we’re referring too – such as percentage falls in markets without a bounce, the level of ‘fear’ in markets, a jump in fixed income ‘stress’ indicators – have actually registered even greater extremes than those that indicated the bottom of the selling in 2008. That said in the last few days, we have seen some growing evidence of and hence improving probabilities for a sustained rally. We will look to tactically benefit from any bounce, even if short lived, before taking on a more defensive stance once more. We are actively managing the funds like we never have before, almost minute by minute. Whilst it may still be premature to make too much of, it’s clear that already the market correction has created some multi-generational buying opportunities in certain companies. We believe there are more to follow in the weeks to come – even though that will likely mean keeping powder dry for those opportunities for a little while yet.
CONCLUDING THOUGHTS AND A RALLYING CALL: ‘THE ONLY THING WE HAVE TO FEAR IS FEAR ITSELF’
Government and central bank intervention needs to be two pronged at this point. Initially, it needs to be of such a shock and awe size, so comprehensive, that investors can take comfort that there is a serious economic backstop in place and the measures are in place to help businesses survive. These measures are being unveiled. In essence, Rishi Sunak, the UK Chancellor of the Exchequer has written a blank cheque for the UK economy – in a bold move, which is actually an extraordinary’ whatever it takes approach, for any government, particularly a conservative one. This was the third emerging measure
announced in the last 10 days and should be applauded.
However, swift action also needs to go beyond stemming the tide. It needs to provide a focal point for investors to see beyond the immediate challenges and recognise a further stimulus to an enduring recovery is on the horizon. Michael Bloomberg, amongst others, has called for the largest public investment in infrastructure in generations.
Such infrastructure investment program has been seen before – more importantly, has been successful before. In 1933, President Franklin D Roosevelt – himself diagnosed with polio, which was subject to its own epidemic, declared ‘The only thing we have to fear is fear itself’. He was referring broadly to a nameless fear that can lead to paralysis by analysis, meaning retreat rather than advance. Massive infrastructure spend was a central plank in the economic recovery that followed 1933. We expect that such announcements globally can not only be a foundation upon which investors can become more positive, and give them reason to expect a government spend led recovery in the coming months – but
there is the welcome benefit that it would allow countries globally to build new, energy efficient and economically enabling infrastructure for the decades to come.
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