The coronavirus has thrown the markets for a loop, understandably. Half of the solution is understanding the problem, so we are reassured by the universal and unified policy responses globally.
Global policy resolve can end crises and cause or sustain bull markets
I recall three such periods of global policy resolve during my career, each of which launched or sustained significant equity bull markets: The Plaza Accord in 1985, Y2K in the mid-to-late 1990s, and the Global Financial Crisis (GFC) in 2008–09. Each response was either in anticipation of or in the midst of serious economic setbacks and, although some of the bull markets ended in excesses that required correction, investors enjoyed equity appreciation for a minimum of two years.
After a 50% increase in the US dollar from 1980 to 1985, finance ministers from around the world gathered at the Plaza Hotel in New York City, acknowledged the risk of widespread deflation in a dollar-starved world, and coordinated policies to normalise the dollar.
In response, the S&P 500 nearly doubled during the next two years.
On the heels of a Computerworld article, “Doomsday 2000” in 1993, Massachusetts programmer David Eddy coined the acronym Y2K in the middle of 1995, inspiring books like McGraw Hill’s “The Year 2000 Computing Crisis” in 1996 and guidelines like the British Standards Institute’s “Year 2000 Conformity Requirements” in 1997. As governments around the world aimed both fiscal and monetary policies at thwarting a technology-related economic meltdown at the dawn of the new millennium, the S&P 500 nearly quadrupled during the four years from mid-1995 to late-1999.
Finally, during and after the subprime mortgage meltdown and Lehman Brothers’ bankruptcy during the GFC, fiscal and monetary policymakers around the world united in their efforts to prevent economic collapse, highlighted famously in 2012 by European Central Bank President Mario Draghi who proclaimed, “…the ECB is ready to do whatever it takes to preserve the euro… And believe me it will be enough.”
Since its low point in March 2009, the S&P 500 has nearly quadrupled.
Global policymakers are united in attacking the coronavirus and averting recession
So, here we are again, this time facing the global economic consequences of a virus named “SARS-CoV-2” and the disease it causes, “coronavirus disease 2019”, abbreviated as “COVID-19”. Governments around the world are responding once again with resolve, both fiscally and monetarily.
Last week, in an effort to understand how serious COVID-19 is, I interviewed Professor Isaiah (Shy) Arkin, the Arthur Lejwa Professor of Structural Biochemistry at The Hebrew University of Jerusalem, whose expertise includes flu viruses. Please find the link to our podcast here.
While discussing the worst, best, and most likely outcomes, without downplaying how serious this virus is, I began to believe that social media fears have gone more viral than COVID-19 will, causing more hysteria — and stimulus — than otherwise might have been and will be the case. Indeed, this coronavirus does not seem to be hitting the young, an observation that social media seems to have missed. In the course of comparing COVID-19 to the common flu, most of us have gained meaningful perspective on the statistics: in the US alone, the winter flu typically impacts roughly 35 million people, nearly 10% of the population, and kills almost 35,000 people, disproportionately the elderly and the young In contrast, as winter draws to a close in the northern hemisphere, COVID-19 has impacted fewer than 100,000 people thus far, not just in the US but globally, killing fewer than 3,000, six of them as at the time of writing in the US. That said, because COVID-19 hit US shows much later than it did Asia and Europe, with testing beginning in earnest just this week, the odds are high that negative headlines will persist for several more months.
While the mortality rate seems higher than that of the typical winter flu, the total number of cases is likely to be much lower, not only this year as spring approaches, but also in the future now that vaccines are on track for approval in record time. While this time could be different, viruses tend not to survive in warm weather, so the odds of sustained human and economic duress are diminishing. Moreover, the precautions that consumers and business have taken to avoid COVID-19 could limit the number of cases and deaths typically associated with the more traditional winter flu.
The Odds of a Global V-Shaped Recovery Have Increased
Given the extreme policy measures in force in China and elsewhere, the odds of a V-shaped global economic recovery from this short-term shock have increased. Election year stimulus in the US already seems to have greased the skids.
For the past year, I have been struck by the dichotomy between consumer and business confidence and spending in both the US and China.
Until COVID-19 hit, consumer confidence and spending had been strong while businesses were retrenching. As measured by Bloomberg’s weekly Consumer Comfort Index in late January, US consumers hadn’t been as confident since the year 2000. Around the same time, the US Purchasing Manager’s Index (PMI) had plummeted to a four year low. Consumers have been responding to record low unemployment rates and accelerating wage gains while businesses have been unsettled, if not buffeted, by various trade conflicts and flattening to inverted yield curves. Historically, inverted yield curves have been harbingers of recession within 12 to 18 months but, as I have delineated in previous letters, they were commonplace during the last period of truly disruptive innovation in the 50 years ended the Roaring Twenties. In China, the story is the same: until recently, consumer confidence and spending had been strong while its PMI had plummeted.
In other words, inventories and capital spending have lagged well behind the optimism associated with consumer spending gains for an extended period of time, typically the recipe for a V-shaped recovery. In our view, while real GDP could be hit through mid-year by cancelled flights and conferences and other business disruptions causing another round of inventory and capital spending cuts, the rubber band associated with a global rebound has been stretching for more than a year now.
As a result, a V-shaped recovery could surprise significantly on the high side of expectations during the second half of this year into 2021.
Innovation gains traction during tumultuous times
During the worst financial crisis of our lifetimes, innovation gained more traction than most investors had expected. Companies offering faster, cheaper, more cost effective, and creative products and services gained significant share. Software-as-a-Service and online retail were prime beneficiaries during the GFC. As technology budgets were cut by 20 – 30% in and around 2008–09, for example, Salesforce.com chalked up a 20% increase in revenues during its worst quarter. At the same time, while retail sales were falling, Amazon delivered 14% growth during its worst quarter.
We believe that the turbulence caused by the coronavirus is giving innovation another opportunity to break through the traditional world order.
Each of the five innovation platforms evolving today is offering solutions to the problem. Thanks to breakthroughs in DNA sequencing and artificial intelligence, researchers sequenced the COVID-19 virus in just two days, compared to five months for the SARS coronavirus in 2003.18 As a result, the FDA is likely to approve the first vaccine in a few months instead of 12 – 18 months, well ahead of the next flu season. In response to disruptions, 3D printing, robotics, autonomous technology, and blockchain technology are likely to gain traction as companies streamline supply chains, not only pushing production closer to end consumers but also accelerating the time to market and facilitating transactions much more efficiently than business processes can accommodate today.
COVID-19 has gone viral, with social media instilling fear — if not hysteria — and exacerbating the dichotomy between consumer and business behavior that has been in place for more than a year. While inventories and capital spending are likely to fall during the next few months, governments around the world are united in their response and resolve to resurrect demand, a dynamic that has been associated historically with buoyant equity markets. As a result, the odds of a V-shaped global recovery are increasing.
As is typical during periods of turbulence, consumers and businesses are willing to think differently and change their behavior. As both look for cheaper, more productive, or more creative ways to satisfy their needs, we believe that disruptive innovation will take root and gain significant market share.
Not everyone sees the next big thing coming
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Sorry I disagree, we're more likely in for a u-shaped recovery. The US used it's war-chest during the GFC. Where can you go when you've reached zero percent interest? Where's the stimulation going to come from? They've been printing and distributing money for years, which only waters down its value. Plus government debt in many countries has past the point of no return.
A very brave call Catherine.
I would be very interested to know when there has ever been a so-called 'V-shaped' recovery after a stock market fall of this magnitude. Or even after a stock market fall of half this size? There has only really been one V recovery and that was in the early 1950's in the USA when markets had true momentum and were re-building from the scourge of WWII. GDP growth was between 4 - 5%, there was little corporate or household debt and markets had not been artificially pumped to stretched P/E levels via the use of QE. Today, governments, corporations and individuals are sitting on a debt pile that defies all economic logic. The rug has just been pulled from under the feet of the world's central banks that were struggling to get GDP growth of 2% and I think we are going to take the medicine that we should have during the GFC. But gee, I hope you are correct!
Too premature of a call. I'm an aussie based in Valencia, Spain. Wait until you guys are in full lockdown with police patrolling the streets with loud speakers. You've seen nothing yet...
I agree with you Leigh. Ali barbers magic carpet has vanished.
Sounds a bit too close to all the people in the beginning of the last GFC who were determined it would all be fine. Of course the market will correct over time, but downplaying the enormous economic impact we are, and will continue to face, isn’t helpful. Globalisation meant that there were counties (Cambodia springs to mind) who didn’t feel the ripple of the GFC until years later. The seriousness of the disease itself is irrelevant to the economic turmoil it has created. We are in unprecedented times, it is naive to compare 2019 to even 2008 with the exponential growth of technology and the interconnected nature of global markets.
I honestly don't mean to be rude but I'm getting a little fed up with people who are not medical professionals or virolagists commenting on health issues. I agree that there will be a rubber band effect but companies earnings are a complete unknown here. How can you make that call without knowing how good or bad they are. Anyway it was a good and thought provoking article
Very brave call. We are nowhere near the bottom. The monetary policy is already failing. Billions of dollars and rate cuts and the stocks keep plunging. Reserve requirements are zero which was established to avoid a crisis. Running out of ammo. Medical crisis needs medical solutions, not fiscal solutions.
Wow! I think the probability of this occurring is somewhere between nought and zero. It doesn't matter what governments, Reserve Banks or G7 do ... this is a crisis of confidence fueled by fear. Throwing money at it will do very little ... the market will turn when a vaccine or treatment that slows it is found.
While markets tend to be reactive & myopic during crises and share prices extremely volatile with a heavy bias to the downside, this is an event unlike any other in history which makes future predictive calls based on historical experience redundant. Because of the unknowns, markets are understandably in panic. However, as has every crises this too will pass. Whether that will be in months or a year or two, strong businesses will survive and in time thrive again and the price the market is willing to pay for that business will reflect that. That surely must be the focus of every investor. Panic guarantees one outcome, rash decisions based on emotion. That rarely ends well. Whether a V or U recovery occurs will depend on how governments address the health crises initially and their economic policy response concurrently with viral mitigation measures and later. We do have some clarity of the possibilities in the near future however. Singapore & Taiwan have very small total infection numbers that are already falling. South Korea & China both controlled rapidly increasing infections within months. Workers are returning to work, children are at school and business is open again. With coordinated government fiscal & monetary response a V recovery would seem plausible but it's predicated on how the virus is dealt with initially. If infections drag, a V recovery is less likely because of sustained economic damage encompassing business failure, defaults, unemployment etc Once a recovery is anticipated- not started, markets may well respond to the upside with unprecedented strength in a very short time especially so if infections were muted. I often read that many western governments now have little or no spare capacity for economic stimulation; that the 'ammunition is spent'. That may be the case with monetary policy but I think the fiscal policy response will be immense and will make an appreciable difference albeit at the expense of public balance sheets. Ultimately, liquidity will be turned on and markets supported by government. Post infection, the demand & supply 'shocks' will abate quickly under stimulus. Governments have no choice. Markets do have an implied government guarantee against total failure and will throw everything they have (and then some, if not a lot more) to ensure that does not occur. This is not the end of the world as we know it. Markets will respond in time. Historically, the greatest investors wealth foundation was established on their long term conviction in great businesses purchased at opportune times. This arguably will be the most opportune time of our lives to date.
I tend to agree with the writer. This drop in the equity markets has been totally irrational, based on fear. During the Spanish flu, which killed 50Mill people, the DOW only dropped 10% from its peak in 1918 to trough in 1919. We are nowhere near that number and never will not be. China has got it under control and the "experts" who say , Australia will have 150,000 deaths are talking rubbish.
I agree with you Catherine. We look at the volatility and it has been up or down by 10% in a day. The market doesn't really know which way it is going. It's reacting to news on a daily basis and Mondays are the worst when people have time to absorb more news and think over the weekend. Political reaction has been massive feeding the fear. It is certain this crisis will end. It's only a matter of time. It took quite a while for the market to react to the first signs of the virus and since then the fall has been dramatic. It is likely that the rise in the market will be just as dramatic when the end of the virus is in sight. Everyone will see it at once. And at that stage all the fiscal and monetary policy moves will kick in. Interest rates near zero. Who won't pile into assets? As you say Catherine the first signs are already there but who sees them?
Hi Catherine, It seems to me you have underestimated the impact of this virus. The main point is that governments need to close down countries in order to stop the spread of the virus otherwise it might kill even more than the Spanish flu in 1918-1920 partly because health systems could be overwhelmed. Read some material from actual doctors in Italy! Can't be directly compared to the flu as it has a much higher mortality rate - perhaps 20x, more variable symptoms, and is possibly more infectious. The virus is completely new so we don't have much information on how it will evolve. The more likely long-term solution is to put pressure on China to close down completely the live animal markets there. SARS came originally from cave-dwelling bats in the Yunnan province in China.
The chances of a V recovery are at very best 30%. After an historic 10 year plus bull market, the Covid-19 virus was just the black swan event that created the catalyst fore the pullback, which now has exceeded 30%, so we are now officially in a bear market. V recoveries are extremely rare on any time frame. World stock indices have all reached declines that will put most countries into a recession, and as one commentator has already pointed out, its medicine we should have taken in the GFC. I think you will find the recovery will be more of a drawn out trading range for many years to come. It may well be broad enough for both bulls and bears to take profits, but I think its a long bow predicting a V retrace.
No Catherine, I think you are looking at it too simply. The GFC was a credit issue only. This Coronavirus has affected demand, and supply and confidence and cashflow. Its effects will be felt by individuals, companies large and small and Governments. The ramifications will be much more drawn out than a V shaped recovery would imply. If the negative impact is less than 2 quarters I would be surprised. In closing the GFC by the way did not result in a "lesson learnt" The private company debt has now moved into massive debts by Governments around the world, which are reaching "tipping points" and even worse scenario to contemplate than the Coronavirus!. Bert
It's feels good being an optimist, but it's better to have a sold basis for feeling that way. Have you noticed that everyday a "record" number of new CV19 infections are reported along with higher daily death tolls? That's because this virus has spread exponentially and will continue to do so until we have a vaccine. Why? Because no matter how careful most people are, humans are inherently sloppy or overconfident in our hygiene and social practises. Moreso in a multi-cultural society like ours. Not good in the face of a new virus with an R0 spread rate in excess of 2 and a death rate so far more like 30 times the seasonal 'flu. That's expected to increase greatly once health systems are overwhelmed as they soon will be due the exponential spread. None of us likely have immunity, so the rate of illness once exposed will inevitably be much higher than 'flu. If you are old, get infected early if you want to maximise your chances of getting a ventilator.
I can assure you there is no V-Shaped recovery coming. The next thing coming after self isolation will be global markets actually closing. Then you will see real panic.
Catherine I think you have got this one dead wrong. Already in Newcastle NSW there are small businesses closing - admittedly they were in a weakened position to begin with. This is a financial nightmare for some, soon to become a financial and human nightmare for nearly all of us.