Two key issues were the main focus of attention during February:
- The Coronavirus (COVID-19)
- The expected mixed reporting season as companies reported December results during the last two weeks of February
The Australian Stock Market fell 120 points on the first day that the virus was reported i.e. 31st December 2019, reducing the increase in the ASX/S&P 200 index to less than 1% for the 6 months from 1st July (6648) – 31st December (6684). But the markets initially globally viewed COVID-20 as a temporary phenomenon. During January the Australian Stock Market rallied during the first three weeks of January by 448 points to 7132 on the 22nd January i.e. by 6.7%. This rally was spurred by confirmation from a number of sources that interest rates were likely to be further reduced, and in an environment of lower for longer interest rates, shares paying recurring dividends were seen to be worth more.
During the latter half of February, reports of COVID-19 being highly contagious in nature brought Wuhan in China to a stop and many countries including Australia imposed travel restrictions in a bid to quarantine the virus. As fears of contagion grew, the markets reacted fearing a Black Swan event i.e. an unexpected event which comes in from left field and creates a large negative return. The Australian share market fell from 7190 to 6441 on the last trading day of February i.e. just over 10%. The US market had gone on a tear after President Donald Trump was not impeached, so COVID-19 caused a greater correction from 29,500 on the Dow Jones index on the 14th February to a 15% correction at times on the 28th February when the US Market was off 1000 points, only to rally to close down 357 points on the day at 25,409.
This Black Swan event will continue to unfold during March. COVID-19 appears more contagious than SARS but less potent. Older men in China have shown a higher mortality rate, whereas older women and young men appear less impacted. A possible explanation may be the higher incidence of smoking in China amongst the older men as compared to the other two demographics. A large number of cases (the Chinese have suggested 80%) are mild with strong recovery rates. The four cases in New South Wales and the two plane flight rescues from Wuhan have all been released after 14 day isolation periods. This is encouraging. On the other hand, reports this week indicate senior levels of the Iran Government have contracted the virus and Australia has just announced a travel ban on Iran. A region
of Italy also has seen a high transmission rate and contagion like effects across three European countries as persons infected travelled from the Italian epicentre. Looking forward, several groups are confident they are well advanced with the development of a vaccine, including a group in Australia and an unrelated group in the USA. The leading company in the USA (Gilead) in the HIV drug space has also announced it is seeking to repurpose those drugs for COVID-19. It seems likely that a vaccine will be produced, so in looking forward, the period up until vaccination is likely to see the movement of people considerably reduced particularly non-essential travel and thus there will be material impacts on hotels, airlines, theme parks etc. This may be offset by some increase in domestic travel over international travel, but many will elect to stay at home in 2020.
Supply chain impacts is the second area of discussion. China is a low cost producer of goods for many businesses globally both large and small. The Chinese New Year has the effect that global companies increase inventories in anticipation of the Chinese New Year shutdown. COVID-19 hit China dramatically during Chinese New Year, as a result of which the factory re-openings were delayed. Initially finance and other businesses were encouraged to reopen with the Chinese trying to get factories to reopen during the last week of February. Some estimate that around half of Chinese factories have reopened but hopefully more accurate numbers will be forthcoming during March. If you were the owner of a factory in China, you would be careful to have different teams of workers and for them not to be mixing in case one contracts COVID-19 and that team has to be put into quarantine. For the factories where workers come from other provinces, there will be reluctance on families to separate, knowing that if a loved one contracts COVID-19, the transport to a quarantine centre may be fatal. SME businesses dependent on China for some of their inputs will be fearful of supply chain disruption. The BHP interim results presentation on 18th February noted that there had been no real impact on shipments to China so far, and that if the Coronavirus was not well contained by the end of March, it was likely to impact on growth forecasts.
Your diarist has faith in the medical and pharmaceutical professions that a vaccine will be produced. Usually such vaccines take years to be developed, but this Black Swan event may result in the shortest approval times ever. In the meantime, fear may result in markets over correcting to what should not be an event beyond 2020. While prediction is difficult, a Yin and Yang set of cycles may be the more probably prediction. There will be a continuing flow of negative news around the issues discussed in previous paragraphs, but on the positive side, progress on the vaccine and continuing low interest rates mean that companies paying dividends will be favoured by the market, particularly if those dividends are not overly impacted by COVID-19. It remains to be seen whether the already weak projections for the Australian economy bring forward not only monetary stimulus which would be expected, but fiscal stimulus. Global GDP will certainly take a hit around the world.
The key macro issue was that in Australia we had seen an expansion of valuation multiples (P/E expansion), while earnings growth was forecast to be negative in the February reporting season. In the USA, there has also been valuation expansion to a similar degree, with weak positive earnings forecast. It is beyond the scope of this blog to comment on individual companies. You diarist has always left those issues for individual discussion with advisors and research reports.
The Australian Reporting Season was mixed. Against this background, COVID-19 may be seen as a catalyst or excuse to reverse some of the valuation expansion both in Australia and overseas, returning the markets to more traditional P/E ranges.
The Yin and Yang effect will again be that if interest rates are further cut in response to the weak global outlook, then equities will be favoured, particularly where dividends are seen as sustainable.
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