After a crash of almost 10 per cent on Wall Street on Thursday 12 March 2020, Australia’s S&P/ASX 200 share index fell a further 431 points or 8.1 per cent to a four year low of 4873, before recovering 13.7 per cent from the low to finish up 4.4 per cent at 5539 - its best intraday bounce on record.
It was an extraordinary two days and an event one only sees a few times in one’s life. At its low point, the S&P/ASX 200 had fallen 32 per cent from a record high of 7162 in just three weeks, having experienced its fastest shift from bull to bear market in recent history.
So we now know what the market reaction to a global pandemic looks like in the first three weeks. Prior to this, the Australian market had treaded water from 1 July to mid October 2019 and then managed a modest 2.5 per cent rise to 31 December.
What do we know about COVID-2019?
It is highly contagious, less dangerous than SARS, but still potentially fatal, an outcome more likely without quarantine, particularly for older demographics and those with pre-existing conditions. It is the contagion effect that has caused fear and panic with markets.
There will likely be a vaccine in 3-6 months. University of Queensland have updated their progress today, believing their vaccine candidate S-Spike will prove effective. Testing in animals has commenced & a meeting held with Australian TGA (Therapeutic Goods Administration) on Friday to map a fast-track forward.
Crucially, the researchers know with certainty that the vaccine works on coronavirus—not COVID-19, but its close relative MERS, the lethal Middle East Respiratory Syndrome. With a fatality rate of 30 per cent, it is many times more dangerous than COVID-19, though thankfully far less contagious. UQ completed this work before the outbreak of COVID-19. The efficacy of the molecular clamp platform should expedite efficacy i.e. safety approvals. Until a vaccine is proven, it is likely non-essential travel will be delayed—probably most will re-schedule for 2021.
COVID-2019 broke in Wuhan in China. The rate of increase in Chinese new cases has declined dramatically, with the Shanghai stock market recovering in line with that declining rate of increase - mathematicians call this the “double derivative” i.e. the rate of change in the underlying dataset, here COVID-2019 new cases. At least half of reported cases have recovered. Chinese supply chains are staging a remarkable recovery, an advantage of a command economy. The ports in China are back open and goods are being shipped.
Australia has shown good management, with containment, travel to high risk countries suspended and a fiscal stimulus package that is well targeted. Your diarist has as a central case a short sharp recession in Australia of three quarters. That is hardly surprising, given this Black Swan event.
Singapore has also contained with no deaths in 187 cases, containment, fiscal stimulus and travellers from certain countries denied entry or transit.
Burrell have, for some time, been suggesting a ten percent cash holding, reflecting concern at some market segments, particularly growth stocks, being overvalued. Sales of these stocks lead to some under performance in the January rally. That FOMO (Fear of Missing Out) rally was in response to failure of the Trump impeachment and low interest rates. Interest rates are about to be the lowest in our lifetimes. So when the market can see past the COVID-2019 event, the FOMO rally may be stronger and quicker than in past major bear markets. Friday’s recovery is in point.
The fact it is a one off event, will largely be killed off in the northern hemisphere by the impending summer heat in 6-8 weeks and that several groups are confident of a vaccine means this FOMO recovery is likely closer than the average non-advised investor may think. However the FOMO rally will likely be after the rate of increase of northern hemisphere cases starts to decline.
The GFC (Global Financial Crisis) bottomed in March 2009. The majority of clients who bought through that time were well rewarded over the ensuing five years. It is always a game to try to pick the bottom, but we really only know after the event. Rather the market is great value, although not all listed companies are equal. Burrell have a list we are reviewing daily of stocks seen as excellent value but with less risk than others. We also have lists of industries/stocks we are avoiding or involve higher risk. We are currently screening the Burrell Universe database for higher debt. This data is standard in the Burrell Universe. These analyses are not easy in the midst of the evolving COVID-2019 crisis. Those who bought last week will likely look back and rather than nibble, wished they had backed the truck up.
One observation from the GFC, is there were four reactions:
1) Those who sold out early, but wouldn’t buy back in from March to June 2009.
2) Those who didn’t sell, but bought through the March to June 2009 period.
3) Those who had cash and bought through the period
4) A handful who panicked or had margin calls and realized the losses.
The lesson here is:
a) Don’t join those who sold out last week (almost no Burrell clients)
b) Buy good value stocks that fit your risk profile
c) Avoid companies with high debt
Is there worse to come?
Italy reports 250 deaths in one day, the biggest daily increase reported by any country. Total deaths stand at 1266.
The US also did not quarantine in the early stages of COVID-2019, so the number of cases is set to escalate. This may cause the US market to continue to show high volatility, despite the Fed and some stimulus last evening. The US was at higher valuation multiples than Australia. We did some nibbling in the US Thursday night and were well rewarded with the Friday recovery. But there may be further downside in the US. The double derivative has not decreased in the US and likely has a way to run up.
In 2009 investors from the US kept selling Australia to repatriate funds to an increasingly cheap US market. It is possible this was a factor last week and will be over next six weeks until northern summer and decline in double derivative in the US.
There are signs of global panic especially in Europe, which will result in near term volatility. That’s Ok. More time to finesse portfolio selections for Australian section of portfolios.
In 2009 the GFC was accentuated by the failure of Lehman Bros.
These periods of market dislocation are poison to companies with poor Balance Sheets. A possible financial X factor is the main risk of concern to your diarist. Previous Blogs have noted the European banks have not recapitalized in the same way as the US and Australian banks. The likely recession in Italy may test those banks with poor balance Sheets. The hedge book of Deutsche Bank is in runoff. This Friday is triple witching. The Fed has reported irregularities in Treasury markets over past two days.
Triple witching hour is the last hour of the US stock market trading session on the third Friday of every March, June, September and December. Those days are the expiration of three kinds of securities: stock market index futures, stock market index options and stock options. The options book was so large - the German Government likely could not/would not bail Deutsche. Notwithstanding the foregoing, Moody’s and other rating agencies have repeatedly reconfirmed the Deutsche investment grade credit rating.
Other corporate failures likely
President Trump as an extreme narcissist has limited empathy with impacted groups. This has led to denial in the US and insufficient testing kits and general preparedness. Closing US borders to Europe rather than the proven containment policy will likely send a number of tourist related businesses into Chapter 11 Bankruptcy including airlines and undercapitalised hotel, theme parks etc.
The supposedly unrelated but opportunistic move by Russia to rebuff the OPEC cartel oil production cut raises stress issues for US oil shale producers, widely viewed as highly geared and their financier banks. Thus the dramatic fall in Bank of America and others, only to see a quick recovery on Trump announcing he will fill the US strategic oil reserve to the brim. Pity Australia has none.
Australian markets presented a unique buying opportunity last week caused by fear and panic from COVID-2019. This contagion will be contained and a vaccine produced.
There is likely further volatility. So be a value investor. Don’t get caught by the panic from the crowd. Select stocks you have always wanted to own, but thought too expensive. The FOMO rally will likely be strong. If we are buying at a great discount to FVE (Fair Value) be happy. Don’t be too concerned about existing holdings of quality stocks. This is an event, but not systemic risk.
Enjoy the opportunity.
Sunday 15 March 2020