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A Questions and Answers guide from Completely Financial – 12th March 2020
Why did markets suddenly fall?
Initially, the markets ignored the impact of the Virus in China, even when it became clear it was causing issues and government action resulted in the closure of factories. This was, to a certain degree, caused by a feeling that China’s economy would rebound, as it had done from SARS in 2004. Predictions based upon the experience of SARS suggested the overall impact would be mainly felt in China and Asia. However, once it became clear that the Virus had spread to Europe and particularly Italy, the markets reassessed their position.
What about oil?
The spread of the Virus and an assumption that oil consumption would weaken had depressed oil prices. OPEC and Russia have a deal in place to limit production and help maintain the price of oil, which expires in April this year. Saudi Arabia had asked Russia to extend the agreement and to increase the level of cuts in the face of falling demand for oil, but the Russians refused, and oil fell in price. The OPEC/Saudi response has been to increase their market share by selling as much oil as possible. This resulted in a sharp fall in oil prices which further unsettled the already nervous markets, and the share price in large oil companies fell by 20% overnight.
Will we suffer a recession?
The Global Economy was already slowing and the impact of the measures to contain the Virus will drag many European economies into recession. We feel that this will be a sharp decline, followed by a sharp recovery as measures to contain the Virus are put in place and subsequently removed. This is similar to what happened in China when they restricted economic activity to control SARS.
It is clear governments will, where possible, provide stimulus to the economy with tax cuts, support for business and interest rate cuts. Certain countries such as China, Germany and Northern European economies will have greater scope to boost their economy by increasing government expenditure and reducing tax, due to their relatively strong government finances. Other countries may find this more difficult and the likes of Italy will suffer from the handicap of already having a weak economy and poor government finances.
What about the medium to long term – will the economy recover?
We feel there will be sharp economic recovery as businesses find the impact of the Virus short-lived and we will return to normality. However, like any recession, weaker companies will fail and confidence (consumer and business) will need time to rebuild.
In the future, there is the possibility that the Coronavirus will become similar to the flu, a disease which can slow economic growth, but is manageable. Vaccines, treatments and changes in the way we live will all allow greater control of future outbreaks.
How far will markets fall and when will they bottom out?
History provides us average durations and falls in markets, but what is more important is the reasons for the fall when trying to understand the current markets.
There are two causes of Bear Markets. The first is where there are major underlying economic issues affecting the health of the overall economy, and the second is where unexpected events cause short term economic issues. The latter results in a shorter Bear Market, but they feel worse as there is often little or no warning.
It is our view that we are suffering an event led Bear Market and we expect the duration to be short and similar to the 1987 crash, where share prices recovered quickly once the initial shock was overcome.
Move to cash and time the market?
The problem with calling markets is that much of the movement, both positive and negative, occurs in just a few days. If you are out of the market for even a short period you can easily find you have missed the bounce, having suffered the pain when markets fell. We do not recommend you sell and move to cash, as fear of further falls will often mean you don’t invest until the recovery is well established.
For investors with spare cash who are prepared to look at medium to long term investment, this could be an opportune time to invest, as they will benefit from the hindsight of seeing the market fall and potentially secure the upside of a recovery.
How have your portfolios done in the last three months?
As you would expect, we have seen the value of the UK and Global Equity elements of the funds suffer from the sell off and the portfolios are down in value. However, our portfolios are designed to ensure the Bedrock element provides a steady foundation. Whilst not all the Bedrock funds have maintained their value, due to the range of funds selected, we are pleased to report two bonds are still showing a profit over the last three months, as they have benefited from the falls in interest rates globally.
What if I need cash?
Firstly, we always recommend you have sufficient emergency cash to meet unexpected expenditure and this is the reason why we always ask about the level of cash you hold at your reviews.
However, if you expect that you may need additional cash in the next 12 months or wish to increase income payments, we ask you inform us as soon as possible so we can instruct the sale of Bedrock funds to ensure there is sufficient cash to meet your needs.
Will Completely Financial be changing the portfolios?
We monitor and review the performance of the portfolios daily and make changes as and when required. In the short term, we are unlikely to make changes as we believe our portfolios are well designed to recover from recent falls. Once markets recover and we start to see a return to more normal market conditions, we will make changes to ensure the asset allocation remains suitable.
What do you expect fund managers to be doing within their funds?
In the type of market we have currently, both good and bad companies will see their share prices fall with no rhyme or reason. However, a good fund manager will be looking for opportunities which will arise as fundamentally sound companies with strong dividend and growth prospects have their valuations reduced without justification in the market chaos. Once markets steady and recover, these shares should outperform. We will monitor the underlying portfolios and see how they are adjusted in the coming months.
Will the economy and markets bounce back and return to normal?
The effects of the Virus will be long term and there will be changes in the way our economy works, which will filter through to markets.
For example, service companies may see a greater move to home working, reducing the need for office space and having a positive impact on the environment as the number of commuters are reduced. The greater use of technology could reduce the time spent travelling, the demand for meetings and boost productivity.
For manufacturing companies, the fragility of their global supply chains has been shown and the need for lowering costs may need to be balanced against the desire for a steadier and more secure supply chain. The best example of this is pharmaceuticals, where it is estimated that the closure of just five factories in the world could cause global shortages for many vital lifesaving treatments.
For governments and central banks, the future issues are about how best to deal with the problems that have arisen from recent events. The Virus has shown how more interlinked the world has become and how a global approach is required to deal with issues, where the ability to control the position is only as good as the weakest country’s response.
Conclusion
History has many stories of overreaction and underreaction by governments. If Europe had closed down its economies and enforced better prevention, would the death tolls from diseases such as Plague, Typhus and Cholera over the centuries have been reduced? Whilst the concerns and public health campaigns about diseases such as HIV, SARS, MERS and Swine Flu are all but confined to the history books, COVID-19’s legacy has yet to be decided.
It is clear that even with a mortality rate of under 1% (as estimated by some, whilst others claim this figure could be double or more), COVID-19 has the ability to cause considerable concern to governments, as doing nothing could mean facing the death of hundreds of thousands of their citizens. However, the initial measures did little or nothing to prevent the spread and thus the reason for the more dramatic measures taken to date. For markets, which like certainty, this is all very unwelcoming and especially when the outcome is not clear. Add in the politics of global leaders and their desire to protect their own people, the result is only further chaos.
History teaches us that we have the ability to find solutions to our problems and like other diseases, we will find ways to reduce the risk with the development of vaccines, better screening, prevention and treatments. There are no better examples than HIV and the flu. Where HIV was once seen as a death sentence for those infected, today it is just another virus, with treatments and potential vaccines and cures whilst the flu, which once could kill millions, is treated with annual vaccinations for the vulnerable to minimise its impact on the population.
Once we are through the uncertainty, markets will recover and investors will profit from new opportunities.