Three key themes for volatile markets

The most recent Crestone Investment Forum was held on 26 February, yet much has transpired globally and in Australia since that time. Most pressingly, the coronavirus (a topic discussed at the opening of our forum), has spread rapidly outside China, with more new cases now occurring worldwide than at the peak of China’s outbreak. Globally, human activity has been sharply curtailed following outbreaks in South Korea, Italy and Iran, while fears are growing that US authorities are not well enough prepared.

On 11 March, the World Health Organisation declared the coronavirus a ‘pandemic’. In tandem with evidence of a rising near-term impact on global growth (even as China returns to work), this has led to a sharp move weaker in global equity prices and market interest rates have also fallen sharply. Policy makers globally have been moving quickly over recent weeks, with interest rates being cut in many countries, including the US, the UK and Australia. Fiscal policy has moved more stimulatory in Europe, the US and many parts of the emerging markets. Adding to concern, the recent breakdown in negotiations between Russia and OPEC has delivered a 30% fall in oil prices, raising concern of rising stress in global credit markets.

Diversified portfolios remain the best defence through periods of unexpected drawdown in risk assets, including appropriately weighted allocations to unlisted alternative investments and defensive fixed income assets. These are the periods investors are most tempted to try and ’time’ markets, which research reveals overwhelmingly to be an underperforming strategy in the long term.

The Crestone Investment Forum allows for the exchange of views with our key partners, providing our investment team and advisers with the opportunity to challenge our thinking. While the extent of recent developments was not wholly revealed in our discussions, the much more cautionary tone led us, on the day, to move portfolio positioning modestly more defensive.

We retain a constructive view on the outlook for Australia and the world economy, and expect a recovery through H2 2020 and 2021. But risks to the near-term outlook remain elevated. The impact of the accelerating curtailment of economic activity outside China is yet to be seen, with some risk the expected rebound in growth through H2 2020 may be slower than expected. For now, we remain neutral equities (while reducing exposure to international credit) and watch for key signals of a more supportive environment for risk, including a deceleration in the pandemic’s spread and renewed negotiations around oil.

Three key themes emerged from the forum

• The coronavirus will have a significant impact in the short term—Key sectors, such as tourism, travel and consumer spending, will be impacted, and global supply chains impeded. China’s growth will slow sharply, impacting Australia. Credit markets were viewed as vulnerable given current tight spreads.

• Maintain a focus on your investment horizon—There will be short-term volatility ahead, so look for opportunities where long-term earnings will remain intact. Policy support remains increasingly accommodative. Recent developments have not undermined the medium-term investment case for emerging markets.

• Australia is well positioned but rates will still go lower—Growth is likely to be impacted in the short term and, with inflation low, it is likely monetary and fiscal policy will be eased further. Australia’s equity market was expensive and risks of a further drawdown remain. 

HOW WILL THE CORONAVIRUS IMPACT MARKETS?

The impact of the spread of the coronavirus is dominating news. While the effect is likely to be felt on tourism and education sectors within Australia in the short term, it is important to not lose track of the long-term themes at play in markets. We asked the panel for its views on the impact of the virus, and the key things investors should look out for.

The impact on tourism and education will be significant

Stephen Halmarick, Managing Director, Head of Global Markets Research at CBA, believes the coronavirus is likely to compound the effect that the recent devastating bushfires has had on the tourism and education sectors within Australia. He acknowledged that, although Australian Q4 growth figures are not yet available, concern was already being raised about the impact of these events on early 2020 growth.

Halmarick expects a fairly large reduction in China’s growth for Q1 2020— potentially from 6% to 4.5% and expects it could be trimmed again to 3%. He sees calendar year growth being trimmed from 6.5% to 5.5%.

The speed of the virus' spread will be key to watch

According to Halmarick, the first order of effect is to assess the impact on individual countries from the perspective of tourism, education and activity. Subsequently, any negative impacts on supply chains will be key. He emphasised that, if the virus affects the supply chain, then this could quickly turn from being just a Q1 issue to a long-standing impact: “If the coronavirus affects the supply chain, then the effect could go on for many months.”

Over the longer term, earning should remain intact

Domenico Giuliano, Deputy Chief Investment Officer at Magellan Asset Management, highlighted the importance of considering your investment time horizon. Although there will clearly be some short-term volatility over the next few quarters, Magellan is not changing its view of the world, nor the stocks it has conviction in. While short-term earnings per share (EPS) may be impacted, longer-term EPS should remain intact.

How will the virus impact China?

Alex Duffy, Portfolio Manager at Fidelity International, provided input from an emerging markets perspective. In countries like China, where there is a high level of debt to GDP, Fidelity International focuses on the developed parts of the economy. However, with 80% of the population employed by small to medium enterprises (SMEs), if credit dries up, this is likely to have a widespread effect as most SMEs will not have enough cash to survive beyond three months. He sees tier 2 and tier 3 cities particularly at risk. Considering this, it will be important to monitor how effective authorities are at injecting liquidity into struggling balance sheets. From a medium-term perspective, monetary policy remains supportive, and Duffy expects there will be a fiscal response. The important question is whether this will lead to an inflationary push in the longer term, and how investors manage a portfolio with this in mind.

While it is unclear whether the Chinese authorities will adopt a broad-based response, or if SMEs will get preference, Duffy believes that the longer China pushes monetary policy then adds fiscal policy, its ability to control the balance of payments and maintain the Renminbi over the long term will be challenged. For now, however, he believes China’s policy response has been sufficient.