Coronavirus – Implications for Investment Markets & our Portfolios

Sometimes financial markets get blindsided by what are known as ‘black swan’ events – basically something that is unforecastable. The coronavirus is just such an event.

As of the time of writing, the news surrounding the coronavirus appears to be heading from bad to worse. Not only is the infection spreading globally, but as more and more cases are confirmed, the mortality rate is sure to rise.

What are we doing about it in terms of our portfolios? While we are monitoring the events closely and prepared to respond for both portfolios, the different targets for each portfolio mean that we take a slightly different approach. The DMG Diversified Portfolio (DMGDP) aims to deliver 4% above the cash rate after all fees, which it has been doing since we commenced the fund almost seven years ago. It also has a strong focus on providing a level of protection in falling markets. 

The DMGDP went into this situation relatively well prepared. Over the last six months we have taken profits on some successful trades, have repositioned into positions such as RARE Infrastructure that have the potential to participate on the upside but also should outperform on the downside (relative to other higher-risk options). Also, we are well prepared within the portfolio for such eventualities as our recent rebalancing of the JCB Active Bond Fund position into a combination of Active Bond Fund plus the Global Unhedged Bond Fund within our defensive lineup stands to benefit the portfolio materially should the $A fall in response to the weaker Australian economy, as many expect.

Finally, we have maintained relatively elevated cash levels until a clearer picture has emerged for the 2020 global outlook. In other words, we have adopted a conservative to slightly defensive stance going into this situation, and we feel the portfolio is well set-up to deal with this event. Despite this we have developed a plan to further reduce risk if the Investment Committee decides that it is appropriate.

The Clearwater Dynamic Portfolio (CDP), has a focus on higher long-term returns and will be more volatile. It is also in the early stages of its operation so we can buy investments when markets fall and take advantage of the lower prices. We have been regularly placing investments when we have available cash and will continue to build our exposure over the coming months carefully.

There will be some losses because the coronavirus is substantially affecting China’s economy. Australia’s trade dependency with China far surpasses that of any other trading nation with nearly 40% of our exports heading to this locale. This is by far exceeds our trade share with any single country in recent times. Shutting down major cities in any jurisdiction is bound to have a telling effect on economic activity (imagine if Sydney, Melbourne, and Brisbane were all in lock-down at the same time) so understandably many are worried as to China’s near term economic strength - and Australia’s as well – at least until this event burns itself out.

And burn itself out it will. SARS represented a major concern for financial markets when it took hold between November 2002 and July 2003. However, within the space of just 6-12 months, the epidemic was largely contained. The coronavirus should follow a similar pattern – all epidemics do in the sense that they appear to get much worse before the rate of infection suddenly slows. The onset of the northern hemisphere spring/summer period should help but that said, in some respects, the coronavirus is a ‘bigger deal’ than SARS because it appears to be more infectious and China’s response to date has been far more draconian in the form of stifling movement within its economy.

It is for this reason that early stage estimates have the coronavirus detracting at least 1-2% off China’s GDP performance in 2020. This makes Australia’s already weakened 2020 economic pulse look even more anemic and little wonder many are expecting the RBA to cut interest rates again in the not-too-distant future. Indeed, if things get really bad, there may be some type of Government stimulus package on its way. 

So, in conclusion, the bad news from the coronavirus (both from a human and financial market perspective) is only likely to worsen in the short term, before we see a resolution.  The good news is that both of our portfolios are well prepared and positioned for this. While we do expect periods of losses, we are working on limiting these. We continue to research and monitor the impact on our portfolios and balance these risks with opportunities for growth from good news in other areas. 

by Gary Lucas.