The World In A Week - Corona Crash
Global equity markets saw an increase in volatility last week amid mounting fears of a global pandemic. The MSCI ACWI and the S&P 500 saw the most violent swings, both indices were in positive territory midweek but fell by -1.53% and -1.36% respectively in Sterling terms at market close on Friday. The FTSE All-Share finished the week down -1.77%. In the current environment, investors shifted assets into safe havens such as gold and government bonds.
Slowing global growth continues to be the main concern for markets as the spread of the Coronavirus shows no signs of abating. The OECD and the IMF have revised down their growth figures and the Fed have responded by cutting interest rates between FOMC meetings, which is unusual. The ECB and the Bank of Japan believe they are sufficiently equipped to cope with a financial crisis and are in a position to act.
Unsurprisingly, data continues to show signs of weakening; China’s PMI dropped markedly to 40.3, significantly below estimates of 45.7 and the lowest reading since the survey was launched in 2004. PMI readings below 50 indicate contraction, and while data elsewhere remains reasonably stable, we believe that the impact will start to be felt outside of the Asia region in the coming months with contagion spreading to developed markets.
Moving away from global equity markets to US politics; Biden’s popularity surged in ten Super Tuesday states including Texas last week, reinvigorating his bid to become the Democratic Party candidate. Super Tuesday is the name given to the US presidential primary election day in February and March, when the greatest number of US states hold primary elections.
Biden’s victory sparked the usual derogatory rhetoric from Trump, but we expect the election will be a much closer contest if Trump’s opponent is one with more moderate political views, which, if Biden is victorious over Sanders, would certainly be the case. The real campaigning begins in the summer, which may allow the media to put something else in the headlines and ,hopefully, put the Coronavirus to bed.
The World In A Week - Planes, Trains And Automobiles
It was media heaven last week as the headlines screamed about the worst week for investors since the global financial crisis in 2008. The Coronavirus has encapsulated the fears of investors; like the disease, they fear the spread and fallout in markets will ultimately lead to the next recession.
Policymakers around the world look to grapple with the consequences of transport and supply chain disruptions resulting from efforts to contain the outbreak. A degree of forbearance is needed for companies who have been affected the most from the global supply chain disruption. It is important that any policy response needs to be granular and specific, as the previous blunt tool of interest rates cuts will arguably not be sufficient in this instance.
The Federal Reserve is still the world’s most influential central bank and last Friday Jerome Powell issued a statement that has set expectations for resumption of interest rate cuts in the US. At the beginning of the year, the markets were pricing in just one interest rate cut in the US; this has now increased to three and will probably mean a rare cut during a presidential election.
In situations like this, the best cognitive course of action is to think of the extreme outcomes that may arise. There are two possible consequences from the Coronavirus outbreak: either it ends up being the pin to burst the economic expansion or it acts as a pump to prime the next wave of stimulus.
We would expect markets to continue to be volatile until the spread of the virus is brought under control and there are tentative signs that this is already happening. For investors, now is the time to hold your nerve and not be tempted into a knee-jerk reaction of selling your long-term investments in reaction to short-term market mayhem.
The World In A Week - PRITI Scores
Last week the Home Secretary, Priti Patel announced a new points-based immigration system as part of the post-Brexit reform. This will bring an end to the free movement of labour and will come into play from the 1st January 2021. The new system builds on the Australian immigration model where the objective is to create a high wage, high skill and more productive economy. The new system would require visa applicants to have a job offer from an approved employer at an appropriate skill level and the ability to speak English. Further points are then awarded based on salary and qualifications, ensuring that the UK continues to attract the brightest and the best. The policy is moving away from the reliance upon lower-skilled workers, but this could lead to a shortage of staff in the social care sector where currently foreign workers make up a sixth. The average salary in this sector is £20,536 meaning these workers would not qualify for points under the new system. The policy is the biggest immigration reform in decades as the UK continues to regain control of its borders.
The UK inflation rate rose to a six-month high of 1.8% but is not expected to change the outlook for interest rates when the Monetary Policy Committee next meet on the 26th March. This week also saw the circulation of the new polymer £20 note with almost 2 billion having now been printed. The introduction of the new note will hopefully reduce the number of fraud instances reported with 88% of the forgeries discovered belonging to the £20 note. The new £50 polymer note is expected to be released next year and will feature the face of Alan Turing. The rise of digital finance and the convenience of online payments has reduced the need for cash. In 2018, cash payments formed 28% of total payments in the UK and is set to decrease to 9% by 2028 with the increasing reliance upon debit/credit cards and the rapid uptake of contactless technology. Sweden is the market leader in this space and is expected to become entirely cashless by 2023, the first country to ever do so. The emergence of Swish, an electronic payments service has enabled this fast transition, with only 1% of transactions now being completed by cash.
Elsewhere, the Coronavirus is continuing to cause a slump in global economic activity. The US Purchasing Managers’ Index (PMI) data showed that business activity fell from 53.4 to 49.4 in January, the first time PMI has fallen since 2016. Furthermore, the S&P dropped -0.81% and investors have switched to government bonds. There are now fears that the Coronavirus could become a pandemic and is expected to continue to disrupt the markets in the short term.
The World In A Week - Will Markets Catch A Cold?
Cases of the Covid-19, otherwise known as the Coronavirus, spiked last week, although we note that this is due to the inclusion of reclassified cases. On a positive note, laboratory confirmed cases were lower, which suggests that the disease is spreading at a slower rate, although the death toll has now exceeded that of SARS. The economic impact of the virus has been mixed thus far, but we believe it will have long-reaching, knock-on effects to the greater Asian region. It is thought that the People’s Bank of China (PBoC) is likely to provide liquidity, to ease funding conditions in Chinese money markets in an effort to tackle downside risk posed by the virus and that further measures to support the economy could follow.
Leading into a long weekend for US citizens, who will be celebrating President’s Day, US economic data remained robust. Labour market indicators, especially workers who are quitting for new jobs and small business optimism, were particularly positive. January retail sales rose in line with expectations of 0.3%, this was mostly driven by online and other non-store sales. Earnings also continue to be strong; of 80% of S&P 500 companies that reported in December 2019, 76% beat earnings expectations, which is in line with the long-term trend, suggesting the economy is in rude health.
In the UK, the ‘Boris Effect’ continues to be felt; Chancellor Sajid Javid resigned from the Cabinet following Boris’ request to sack all of his advisors, a request that Javid felt was a move too far. It has been widely publicised that there have been tensions between Javid, and Boris’s top adviser, Cummings, who wanted more control over economic policy and spending in the last few months. Javid’s departure made way for the appointment of Rishi Sunak who has a tall task ahead; with the Budget due to take place on 11th March, it is questionable if this will go ahead.
The World In A Week - Policy Preferences
Last week saw a reversal of fortune regarding market performance as global equities shrugged off concerns with MSCI AWCI rising +4.6% in GBP terms. This was primarily driven by the Chinese and US stock markets (up +6.5% and +5.1% respectively) and rests on the assumption that the Coronavirus outbreak can be contained. A secondary-order assumption stemming from the Coronavirus outbreak is that any economic slowdown will be countered with easier monetary policy from the world’s central banks, namely the People’s Bank of China and the Federal Reserve in the US.
This reversal in sentiment was also observed in the fixed income markets; high yield bonds rallied +0.60% while high quality bonds lost -0.12% - both in GBP hedged terms.
While the assumption that central banks will provide ever-increasing degrees of monetary stimulus to calm nervous markets has worked well as an investment strategy since the financial crisis, signs are appearing that this relationship could come to an end. Negative interest rates are being used in an attempt to stimulate growth in the Eurozone, Japan, Denmark, Switzerland and Hungary. Thus far the success of this experiment has left much to be desired, and the efficacy of negative rates is now being called into question by many. In December 2019, the Swedish central bank, the Riksbank, decided to abandon the negative interest rate experiment and raised rates to 0%.
The ineffectiveness of monetary policy to bolster further economic growth has led many market participants advocating a pivot to fiscal policy to pick up the slack. Governments in the UK and Europe seem to be gradually moving to take advantage of low interest rates for infrastructure spending. In addition, left wing economic policy is coming more into fashion around the globe, Bernie Sanders is leading the polls in the democratic primaries and over the weekend the Irish electorate returned Sinn Fein as the largest party in a general election. We continue closely to monitor policy makers preferences for economic stimulus and how markets will react.
The World In A Week - Love Changes Everything?
Today we could have written about the United Kingdom no longer being part of the European Union, as Friday saw us exit, but without any clarity around the trade relationship for the future. This is the start of the long journey towards clarity around how we will interact with Europe going forward.
We could have written about Mark Carney’s last Monetary Policy Committee as governor of the Bank of England. The expectation for an interest rate cut had surged during January, however the committee voted 7:2 to keep UK interest rates at 0.75%. Mr. Carney officially stands down on 15th March after extending his governorship twice in order to see the UK leave the EU in an orderly manner.
What we are writing about is the Coronavirus and the concerns that this raises with short-term sentiment in the financial markets. Fear is the biggest economic threat and fear spreads more quickly when carried on the wings of social media; Google searches for ‘Coronavirus’ have risen sharply over the past week. It seems fear changes everything.
Fear changes consumers’ economic behaviour and in turn changes policy makers’ responses. In response to help contain the spread of the virus, China extended the Lunar New Year holiday to three days, with financial markets opening today. This has knock on effects for global supply chains and even a short disruption to global manufacturing should not be ignored. Companies should have enough inventory, but if Chinese companies are closed long enough, European and US production may suffer a lack of parts. We would expect sentiment surveys to worsen on the back of this.
The World Health Organisation has now declared the Coronavirus outbreak a Public Health Emergency of International Concern. We believe that international measures to stop the spread of the virus will ultimately prove effective and there are early signs that the rate of increase in the number of new cases is slowing. It would appear the world was much more prepared for this type of outbreak than it was in 2003, with the Chinese government being pre-emptive and transparent, especially in quarantining major cities.
As we wrote last week, action will be compared to the SARS outbreak in 2003 and the blueprint is this current crisis could last between three and six months. We must keep in mind that this period of apprehension will eventually end, but in the meantime, we will probably face more bad news as media sources continue to use more emotive headlines, which will likely impact markets in the short-term.
The World In A Week - Deciphering The Known Unknowns
Memories of what it was like during the turmoil of the global financial crisis have resurfaced, but even in the height of the tumultuous times of 2008 and 2009, the market did not have such extreme one-day movements as we have just experienced.
Last week we had two of the worst days in history of the FTSE 100 and the fall on Thursday was bigger than anything experienced during the throes of the great recession:
Source: Investment Week, SharePad/AJ Bell
In the wake of the FTSE 100’s second worst day in history, the index is continuing to fall, down over 6% at the time of writing and puncturing the 5,000-price barrier, as airlines and holiday firms feel the impact of travel bans and falling demand for flights. The accumulated combination of falls has meant the FTSE 100 is more than 30% below its 52-week high and well into what is traditionally called bear market territory.
The fear of recessionary risks that dominated the end of 2018 have returned, and the record breaking 11-year bull market in the US has ended with the S&P 500 dropping as much as 26.7% from its peak in February. The most obvious question investors are asking themselves is whether we are at the bottom.
Putting last week’s market moves into context is critical. By comparing against the three previous market corrections, namely 1987, 2000 and 2008, we can gain some perspective during these agitated times. Using the historical data of the S&P 500, the main index of US stocks, you can see that while the drops are dramatic, the subsequent recoveries do provide a remedy for the long-term investor.
Source: Bloomberg, Standard & Poor’s, J.P. Morgan Asset Management
While we expect continued disruption to economic activity, we do believe a path towards recovery does exist. Policy makers and markets will continue to act swiftly and decisively to the continually changing situation. The unpleasant truth is no one truly knows what will happen and that uncertainty is exacerbating the reactions in stock markets. However, the landscape has changed dramatically since the global financial crisis and previously unthought of solutions are now possible.
In order to avoid a repeat of the great recession, governments need to allow for unlimited fiscal compensation for lost revenues and wages to all businesses and employees affected by quarantines and lockdowns. Monetary policy is necessary to avoid financial systems collapsing, while fiscal measures, that are designed to support the recovery, should only be deployed once the virus is under control. We had our first budget from Rishi Sunak promising a record-breaking stimulus package of £30 billion to counteract the effects of the Coronavirus. Fiscal expansion is already being pushed by the Government, looking to invest in the UK economy, particularly infrastructure projects.
Central banks around the globe have acted swiftly and continue to react to an unknown environment. This morning we have seen the Federal Reserve’s Open Market Committee reduce interest rates to zero, as they realise the effects of the Coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook.
The Federal Reserve expects to maintain interest rates at zero until it is confident that the economy has weathered recent events and is back on track. What is more interesting was the Committee’s comment that as it continues to monitor the developments and implications around the globe: “…will use its tools and act as appropriate to support the economy.” This will include significant quantitative easing and increasing its own balance sheet once again.
Liquidity is being pumped into the financial system to ensure any signs of strain are bolstered and more targeted support is already primed. This would appear to be Jerome Powell’s ‘Mario Draghi’ moment, as the actions of the central bank are saying they will do whatever it takes to support markets during this unprecedented time.
The Fed’s cut was part of a co-ordinated response from the world’s central banks, with the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Canada and the Swiss National Bank all introducing measures to shore up their financial positions.
While the trigger for the market collapse has been unpredictable, it is at least simple. A market that had not seen a significant downturn in over 11 years, and was arguably over-priced on some measures, met the unknown effects of an alarming and virulent virus. Whether the remedy will be simple is another of the myriad of known unknowns that we face; what we do know is that every market collapse has been followed by a recovery.
While we wait for the signs that we are close to the bottom, which means needing to see a little more clarity and certainty, such as infection rates slowing or evidence of global containment, we need to remember our long-term goals. A pragmatic approach of long-term investing will enable investors to hold their nerve during the most turbulent of times. Rest assured, cognisant of the current market volatility, the investment team continue to execute the processes that have been tested over the past 15 years, to ensure we deliver robust outcomes to all our long-term investors.