Coronavirus, whilst significant in the short term, will pass in the next few months largely as a result of the significant action taken by the Chinese to contain the virus. Nearly all the deaths have occurred where the virus originated (Hubei), and the deaths have been largely the result of not seeking treatment and complications regarding a pre-existing condition.
Given the actions taken by governments to close down ports, borders, and limit air and sea transfers, this will have a material effect on economic growth and corporate earnings in the short term.
Markets will likely look through the weaker data considering investors have largely taken Coronavirus in their stride, and central banks can and will provide short support if required.
Markets have continued to push higher on a few reasons:
- Less political risk with Brexit and phase one trade deal completed
- Fourth Quarter corporate reporting season in the US coming through better than expected with upgrades to earnings expected for calendar year 2020
- Continued central bank support which will remain in place for this year, keep cash rates and bond yields low, and thus encouraging continued investment into growth assets
- US Presidential race looking increasingly likely President Trump gets a second term, which is positive for equity markets versus the alternative.
Absent Coronavirus being a lot worse than we suspect or a Democrat winning the US Presidential election, there’s not a whole lot standing in the way of another equity rally this year. The US economy looks strong enough but not too strong so as to encourage the US central bank to remove stimulus. Europe looks to have found a bottom from an economic perspective, with Germany the weakest link and seriously considering embarking on fiscal spending for the first time in a very long time, which may encourage other European governments to embark on their own fiscal stimulus. Japan looks likely to embark on fiscal stimulus this year as the government needs to counter the effect of GST increases over the last few years.
Other issues to watch out for include a significant slip in Chinese growth (unlikely at this stage given government and central bank support), a re-escalation of US-China trade war (ie. further tariffs), a re-escalation of US-Iran tensions in the Middle East (ie. higher oil price), a significant and permanent spike in inflation (which would cause central banks to remove stimulus).
Closer to home, the Aussie economy is looking for a bottom, but it looks likely there’s further to go, with the bushfires and the Coronavirus significantly impacting tourism. The RBA likely has at least 1 more rate cut in them if not 2 before they get to their lower bound of 0.25%. They’ve recently made comments that they think quantitative easing is off the table, but it’s very premature to be making comments like that, unless they know something we don’t. That could be significant government fiscal pulse in the May budget, which looks unlikely, but is something the economy desperately needs. Outside of that, the only positives in the economy right now are a recovery in the housing market, largely in Sydney and Melbourne, and a falling Aussie dollar which is helping from an export perspective.
Key messages remain as follows:
- Diversification is key – across asset classes, regions, sectors, and investment styles
- Selectivity – given the wide dispersion that exists in valuations between sectors, styles, and regions, being selective (active management) will be more important this year than it has been for a long time
- Rebalancing is important – the best discipline in investment markets goes counter to human behaviour and biases – ie. trimming winners and topping up losers. It has been shown to add 1-2% in additional return per annum
- Time in the market – timing the market remains an impossible task, and trying to time the market in the current environment is likely to result in significant opportunity cost considering central banks continue to provide a floor under equity markets.