My reasons for calm in the middle of a tough quarter

Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
(AMP Capital)

 

At home and abroad, major events have rattled global markets in the first quarter and are set to have an ongoing impact. However, it’s not all bad news, and as always – it’s a good idea to turn down the noise.

The United States and Europe

You might not know it from the headlines, but there has been some positive data coming out of the US this month.

This includes:

  • The ISM (Institute for Supply Management) manufacturing conditions index rebounded into positive territory in January.
  • The non-manufacturing ISM conditions index also rose and it remains solid.
  • Small business optimism remains high.
  • Jobs growth remained strong in January with unemployment remaining ultra-low
  • Earnings seasons results have been generally good: Taking a look at data up to February 7, 64% of US S&P 500 companies had reported, with 76% beating on earnings expectations by an average of 5%. Further, 67% had beaten sales expectations. Earnings growth looks to be up by about 2.5% year-on-year, compared to market expectations a few weeks ago for a 2% decline.

Brexit is (finally) here

The United Kingdom officially left the European Union on January 31, after years of negotiations.

In good news for markets, so far, it appears the UK parliament is leaning towards wanting free trade to continue between the UK and the EU. Time will tell whether a deal is agreed by year end or not. But the key point is that Brexit has not contributed to the domino effect of countries wanting to leave the Eurozone that had been feared a few years ago. If anything, the Eurozone looks more determined to stay together.

Also:

  • In January, Eurozone business conditions PMIs (Purchasing Managers Index) were revised up and are continuing to recover from the lows experienced last year.
  • Likewise, global business conditions indicators also continued to recover in January

News from Australia

For some time, Australia will be dealing with the implications of the bushfires which ravaged the east coast. The mega-blazes which formed over the Christmas and early 2020 periods were largely extinguished after a deluge of rain in recent weeks, but we can expect a hit to GDP, especially in the March quarter.

In saying that, there has been some positive economic data recently.

  • House prices were up solidly again in January.
  • Building approvals fell just 0.2% in December, but this followed an 11% gain in November, and they are up slightly on a year ago.
  • Job ads also rose in January.
  • Retail sales were soft in December, but real retail sales managed an okay rise in the December quarter as a whole.
  • The trade surplus remained high in December

The Coronavirus, China and global markets

The 2019 novel coronavirus, commonly referred to as the Coronavirus, was declared an international public health emergency by the World Health Organisation (WHO) on January 30 this year. This is, first and foremost, a human crisis.

There has been understandable concern about the knock-on impact to markets. At the moment, share markets have seen falls, with the Chinese market taking the biggest hit at about 12% followed by Asian shares. For global and Australian shares there have been falls at around 3%, although some or all of this has been reversed depending on the market.

No doubt, the Coronavirus will have an impact on markets for a while yet, particularly for China. Trade, people movement and confidence has been restricted, so it follows that we can expect the global and local Asian economies to take a short-term hit.

Keeping an eye on context

There are some points about this situation that are being lost in the noise, including:

  • Fear can be louder than reality

The current situation regarding the Coronavirus is highly uncertain. However, the experience with SARS, bird flu, swine flu and Ebola in recent history highlight worst-case pandemic fears don’t usually eventuate.

In the last century, there were three influenza pandemics. The 1918 Spanish flu pandemic was most severe, killing about 50 million people worldwide. Economic activity was severely disrupted as people stayed in their homes, compounded by the end of World War I. Nothing has surpassed this since, which was 102 years ago.

A more relative case is the SARS outbreak in 2003. SARS infected about 8000 people, mostly in Asia, after an initial outbreak in China. SARS had a big negative impact on the countries most affected as people stayed home for fear of catching it. GDP in China, Hong Kong and Singapore slumped by over 2% in the June quarter of 2003. Growth then subsequently rebounded.

  • Containment measures are aggressive

When compared to SARS, the containment measures from China in particular have been more aggressive and started earlier. Airlines and nations worldwide have imposed tight travel bans in and out of China and the Wuhan’s Xubei province, where the outbreak started. This may partly explain why 99% of cases have still been confined to China with about two thirds in Xubei province.

With measures such as these in mind, our base case scenario (with 75% probability) is one of containment over the next month or two. In this case, GDP in China and parts of Asia would likely take a 2 to 3% hit or maybe even deeper. Australian GDP could also take a significant hit in the current quarter as resource exports, tourism and education are impacted and this could see GDP go negative. But growth would then rebound in the June quarter. If this occurs shares, commodity prices and the Aussie dollar could see more volatility and downside in the near term but will largely be able to look through the short term economic and profit disruption to the eventual rebound.

A cool head

As I’ve long said – keeping your head calm in extreme times is critical. This includes when the crowd is convinced that disaster is upon us. These periods present temptation to make fear-based investment decisions, which seldom reaps results. So, in the interest of your investments long term best health keep calm, and carry on.

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