SPECIAL MARKET UPDATE – REVIEW OF RECENT DEVELOPMENTS
24 March 2020
Obviously, my notes to date have been rather sombre, but factual and real. I’d rather inform than paint false narrative
I’ve been looking for some positives to write on of late to counter all the negative news flow and have come across three fantastic information pieces over the last day and night which I think will help everyone’s psyche as present, even my own.
Bailout – Firstly, it looks increasingly likely that governments around the world are preparing for the largest mobilisation of stimulus we’ve ever seen. With the GFC, governments selected who they saved and who they didn’t base on those that were essential services / national interest and those that were most responsible for leading into the crisis. This time around they’re unlikely to discriminate as no one could have foreseen the economic impacts of the virus. While we can’t say for sure everyone will be saved, new information flow from those in-the-know indicate that governments are preparing packages in the billions and trillions of dollars, which will be financed via debt with little to no recourse. That debt will be purchased by central banks who will need to print more money than ever before. Any non-performing loans are likely to be absorbed by the government and segregated / ring-fenced, with the debt either forgiven or worked out over the very very long term. Hopefully, governments get their act together and get this legislated as soon as possible. There is no point waiting, and there is no point trying to figure out where it lands – go hard or go home. The only negative here is the US, where the Democrats are holding up President Trump’s US$2 trillion-plus stimulus package on the basis they want to control who gets it……now is not the time to be quibbling on who gets what. Get it out into the economy and then decide on whether more is needed. Surprisingly, the lead has been Germany, who before the virus was maintaining a budget surplus even though their economy was in recession, has put forward a colossal package pushing them into significant deficit for the foreseeable future.
Secondly, the US central bank announced last night that they would do whatever it takes to save the economy and those in it. The technical aspect is that they will buy US government bonds and mortgage-backed securities in unlimited amounts, effectively back-stopping both markets and providing unlimited liquidity. It has also set up a program to ensure credit flows to the private sector and state / local governments. The European central bank has stepped into the European corporate bond market and is buying 1-2 billion euros of corporate bonds a day, and will likely increase this over the coming days and weeks, potentially up to 6-7 billion euros per day. These same moves will need to be adopted by central banks globally, specifically the RBA, British, and Japanese central banks. Most importantly, the steps push money into the system incredibly swiftly and allow bond markets to normalise. Once bond markets normalise, all other asset markets can begin to normalise.
A recent note from PIMCO, the world’s largest active bond manager, and a few other sources have confirmed the above.
That’s not to say that equity markets won’t be volatile from here and that we won’t see further falls from here – we will, as many companies will be forced to raise equity for cash flow needs, before governments and central banks step in to back-stop them if required.
Containment – in an incredibly insightful, but deeply technical piece (for those nerds amongst us, I’m referring to me of course from Chris Joye and his quants (or data science team as they are more affectionately known) at Smarter Money Investments, they’ve modelled the virus spread, peak, and decline based on data from each country around the world and based on each country’s response to the virus. What this shows is that if the US had South Korea’s efficiency in dealing with the virus (very efficient), then the US’s peak would be this week. That efficiency is unlikely, so if we assume more likely scenarios like 50% of South Korea’s efficiency, then we’re looking at peak contraction the 1st week of April, or mid-April at the worst if we adopt 75-100% of Italy’s efficiency (very inefficient). Apply those same assumptions to Australia (ie. 50% of South Korea’s efficiency) would have us at peak cases around mid-April, with a decline in cases observed in the 2nd half of April. There is the risk that governments and their citizens don’t act as they should, which may extend the time to peak cases. Now is the time to be smart and sensible. That doesn’t mean confining yourself to your home, but it does mean being smart about where you need to be each day and your own personal hygiene. Little to no confined spaces for prolonged periods of time, washing hands before handling food, and don’t touch your face under any circumstances.
Cure and Potential Vaccine – I’ve been trawling through medical journals and updates to get a clearer picture on what is being done / tried / tested on the front line. What’s been incredibly pleasing to see is the efficiency and speed at which those on the front line have been moving, without government bureaucracy, to develop a cure and vaccine. A vaccine is near, but vaccines are problematic in that they must pass rigorous and lengthy testing before commencing completely new production. Timeframes expected here are 6-12 months at present. However, on the cure front, doctors on the frontline in France, Germany, and the US have already begun treating their patients with two drugs already approved for other uses and in production. These two drugs are anti-malaria drug chloroquine, and its safer cousin hydroxychloroquine which is used to treat auto-immune disease and arthritis, and azithromycin which is an upper respiratory antibiotic used to treat things like legionnaire’s disease. It looks like hydroxychloroquine kills the virus whilst the antibiotic has viral responses help the lungs and respiratory tract to heal. In France, the drugs were tested on patients with the virus with incredible outcomes – those that took both drugs were all cured in by day 6 of treatment; 57% of those treated with hydroxychloroquine were cured whilst the rest improved but took longer to cure; and 12.5% of patients who received neither were cured by general care. Most patients globally treated with this combination have cleared the virus in 3-6 days versus the 20 days it takes for those who receive hospitalised care. The quicker clearance obviously means less time the patient has to spread the disease. Critically, the most important takeout is test and test widely, and then use this treatment combination early (ie. not waiting until a patient is on a ventilator and has already experienced damage to the lungs). The only side-effect to note is that hydroxychloroquine can be risky for those with heart disease/issues.
Both drugs are readily available, but now in low supply given they’re used for regular every treatment, so a ramp up of production will be required. Drug companies have committed to ramping up production, but more will be needed. Also interesting to note on the vaccine front that a doctor in the US has been using hydroxychloroquine as a preventative of sorts to protect healthcare workers from infection.
Overall, containment of the virus is still required, as the drugs alone won’t fix this. If you are looking for a credible source on the virus, I will direct you to the following website (https://www.worldometers.info/coronavirus/), which I’ve been on daily since the outbreak began. Whilst the stats showing new cases are incredibly concerning as the virus moves to peak in many countries globally, I have started to notice a decline in the number of new deaths being reported daily, but early days yet. What’s critical next is that the number of new cases starts to decline each day, as does the number of active and critical cases (remembering that approximately 5% of all cases globally are serious or critical), so that hospitals can better cope regarding available beds and ICU equipment.
Hopefully, this provides some optimism to balance out the pessimism we’ve all been seeing, reading and experiencing. There is light at the end of the tunnel.
We’re not saying we’re there yet, but we’re getting closer.
From a portfolio perspective, I would encourage the following right now:
1. Don’t make any rash portfolio changes – now is not the time to be selling
2. Hold off any unnecessary portfolio rebalancing – until we get a clearer picture on government and central bank action
3. Be sensible about putting excess cash to work – take into account things like investment time horizon and risk appetite/tolerance, and dollar cost average into the market over a 3-4 month period (subject to change depending on daily information flow.
4. Potentially leave some powder dry for participation in upcoming equity raises to avoid dilution and take advantage of opportunities.
Peter Bell… Bellmont Securities.