Market Update - April 2020
Update 30th April 2020
Recently we have seen improvements in the virus cases and the financial markets. There is enthusiasm about the relaxation of restrictions and the prospect of getting back to some type of normality. Against this, there are still concerns. Today we cover our latest views and research and what we are doing within our portfolios.
The Virus:
Some countries such as Singapore have seen a resurgence in cases.
The opinions are divided on whether we get a vaccine and if so when.
A leading hope for a treatment drug from Gilead Sciences, initially reported poor results out of China, but overnight the US was optimistic about its ability to treat the virus.
Managing the exit from the restrictions is very challenging for Governments.
This points to the path ahead still being uncertain, and the situation could quickly deteriorate again. In Australia, we have managed the virus very well. Not perfectly, but this is impossible, and every country would handle it differently if they had a second chance, which some are getting.
Oil:
The price of Oil was in the headlines recently due to dramatic price falls as demand dropped caused by the shutdowns. Air Flights have reduced significantly; we aren’t driving as much and use by industry is well below normal levels. Production cuts have been agreed upon, but this has come too late.
Storage is now becoming an issue as Oil is expensive to store and the prospect of holding large amounts is unattractive when there is uncertainty about demand and price. Some countries are topping up their reserves, buying at these depressed prices, but supply is still exceeding demand.
According to one of our fund managers JCB, Oil is the world’s most important commodity and driver of inflation expectations, yet it has fast lost its value. The issues in the oil market are expected to persist over 2020. They will cause waves throughout the financial system given its high correlation to all asset classes and its importance on Wall St, Main Street, and Capitol Hill. The effects should place further pressure on the commodity currencies and high-yield bond markets as well as emerging market countries whose fortunes are entwined with crude.
Another manager stated that at these prices, many Oil producers are bankrupt.
Logic says it is a temporary issue and that prices will return to sustainable levels, but this is not as easy as it sounds.
If this is not resolved soon, the financial consequences will be serious. Some companies may prove to be bargains, but some may not survive.
Share Markets and the Economy:
Questions remain as to whether the current level of share markets reflect the implications of the virus and the measures employed to limit its spread. Or are shares too expensive considering the risks that remain?
During the previous ten bear markets (falls of 20% or more), the average period from top to bottom was a little over one year. This current crisis saw markets peak on 20th February, only two months ago.
Rarely do markets suffer one significant fall and then recover. Usually, there are multiple falls and recoveries before long-term gains persist. In fourteen of the last fifteen bear markets, after initially recovering, shares again fell to or very close to the previous low point.
Corporate Bonds. This is when money is lent to companies, in return for interest payments. In uncertain times, our preference is for the security of money being lent to Governments, even though the interest rate is lower.
Financial crises experience many corporate failures, which impacts the value of Bonds. We have already seen examples of this. The effects of these failures flow through the financial system.
After Banks overseas cut or deferred their dividends, we are now seeing the same thing in Australia. This ends the long-held view that regardless of how much the share price falls, Banks will always pay a large dividend. The implications are serious as many retirees and others rely on dividends for their income.
As we said previously, Banks went into this crisis in excellent shape, and they needed to. They have been required to carry some of the burdens by giving interest rate relief. However, they will also be subject to the usual financial challenges they experience during recessions. Businesses and personal borrowers will default as they will not be able to repay their loans without sufficient business profit or a salary.
Like the economy, the future for Banks and their share prices is uncertain. They are not bargains, nor are they high growth businesses. Their price has fallen because their profits and dividends have fallen.
How will households and businesses manage the catch up of the deferred loan payments and the extra interest bill they have accumulated? This will be a cash drain on the economy and detract from consumption – which is needed to stimulate the economy. The Banks will get the money but they will prioritise restoring their balance sheet and maybe paying dividends, rather than more lending.
Many retail businesses are expecting their online component to be larger in the future. They also expect this to mean less staff and reduced demand for physical buildings. In turn, this means that unemployment will not reduce quickly, and the overall recovery may be slower than many expect.
This is a headline from the New York Times on 21st April: The Death of the Department Store: ‘Very Few Are Likely to Survive’. Again this is dramatic but keep in mind that the reality is that many stores were under pressure before this crisis. The article covers a litany of stores with serious problems. Here is a link:
There is an impact on landlords who must share the downside from falls in sales of their tenants (without the same upside when sales increase).
Over the last four weeks, US unemployment has been at record levels. More numbers will be out tonight. Following that, we will begin to see economic data released regularly that will include the impact from the March quarter. Already we are hearing reports of this possibly being the worst recession in eight decades.
How we are managing the portfolios:
Both the Diversified and Dynamic Portfolios have cash levels that are above the target allocation. This will enable us to transact the same day that we make a decision to invest in growth assets.
The Dynamic Portfolio made some small purchases of growth assets earlier this week as our cash balance continues to grow with the inflow of money from new investors. However, we still have a significant portion available to invest on a larger scale when we feel it is appropriate.
The Diversified Portfolio has a relatively smaller cash balance and we are patiently waiting for a better opportunity to invest.