Liquidity might not work this time, be careful in low quality credit - Part 1

Charlie Jamieson

Jamieson Coote Bonds

The last three major market drawdowns resulted from human behaviours. China’s currency devaluation in August 2015, the volatility blow up in Feb 2018 and the Christmas Eve equity massacre in Dec 2018 were "human episodes" which could/were undone with a change of government and Central Banking policy, often in the form of promised additional Central Bank liquidity.

That is where coronavirus is a different beast. What magical human policy can easily make this go away? That’s worth thinking about as we look forward over the coming months, because we don’t think liquidity can solve many of the demand and supply issues this time.

As we are witnessing around the world, only one infected person needs to travel and pass through customs borders without obvious symptoms to start this entire lockdown process all over again, country by country. We have already witnessed the effects that this has had in China from both a humanitarian and economic perspective.

With health officials now suggesting a pandemic is likely, what will happen to day to day life as we know it? Clearly, those who can will work from home, but as schools and nurseries are also likely close to suppress infections who looks after our children? Who looks after our elderly when health workers need to look after their own families? Football season has vacant stadiums, shopping centres and movie theatres are almost empty, restaurants and cafes the same. So it’s easy to see demand falling towards bare essential items only for a period. But what of supply? Without production who makes all the product we take for granted day to day? How is it delivered to the store and how do we acquire it? These are things we’ve only considered in Hollywood movies, but they are sadly real for many folks around the world right now.

Temporary disruptions can have long term effects

These disruptions are temporary, but the much bigger economic question is what does that do to cashflows, and what happens to the leveraged players? The markets loathe uncertainty and this looming pandemic provides that in spades. Central bankers and politicians will adopt the keep calm and carry on motto, however at this stage in the global business cycle Mr Market will need more than some soothing words.

Asset markets have already made significant adjustments for a material economic slowdown. Given the depth of the cashflow impact on global businesses now, and more expected virus outbreaks yet to come around the world, past investment strategies might require re-examination. Investors have been well rewarded for buying the dip since the GFC, it has worked every time. Will it work this time, we just don’t know. A rate cut doesn’t look after your kids or your elderly parents, it doesn’t keep you safe at the shopping centre. It helps, without addressing the major issues at hand.

Many market participants initially dismissed coronavirus as a temporary shock that would be a ‘’V shaped’’ interruption, and as such markets should ‘look through’. JCB believes this requires deep thought, as its so different from previous market episodes. So much remains unknown about true mortality rates, about the higher level of critical cases where medical facilities are over run (critical with a respiratory disease means lack of oxygen – that is a horrible survival), about those folks who have recovered only to be re infected.

We are all trying to survive this virus in every way. Physically, emotionally, economically. But for the highly leveraged, it can be extra deadly. There are huge possible market implications in that which will reverberate through the financial system and will be difficult to immunise against.

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Charlie Jamieson
Chief Investment Officer
Jamieson Coote Bonds

Charles is a co-founder of Jamieson Coote Bonds (JCB) and oversees portfolio management of the Australian and Global High Grade Bond and Dynamic Alpha investment strategies. Prior to JCB, Charles forged a career as a seasoned bond investor from...

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