The coronavirus outbreak is first and foremost a human tragedy, affecting hundreds of thousands of people. It is also having a growing impact on the global economy. Both markets and policy makers have gravitated to this being a pandemic as they respond to the virus. However, this underweights the possibility of a more optimistic outcome. A social media driven news cycle and the interconnectedness of global supply chains has led to one of the sharpest 15%+ corrections in history.
Heightened volatility in the stock market tends to translate into increased emotional volatility. This is not a time to panic as history suggests that markets recover strongly after such episodes. As with terrorist attacks and financial crises, epidemics generate widespread uncertainty and sometimes panic. Government authorities and private individuals often respond by drastically reducing exposure to the shock, amplifying its global economic impact. The virological elements of coronavirus are well beyond our capacity to predict and therefore there may well be further pressure on the downside. But make no mistake! This will end and when it does investors who panicked will probably miss the recovery and may end up damaging their long-term investment plans.
Reasons to be Positive
Previous periods of market corrections have proven to be excellent buying opportunities
Strong policy response from central banks, helping to loosen financial conditions, should start supporting the downside particularly in the credit markets which typically are the first indicator of a more systemic risk. This will be further supported by fiscal policies to support small businesses and individuals.
Improvements in technology and advances in medical technology means that scientists will come up with a solution faster than what was possible in the past
Analysing Previous epidemics
Whilst the Coronavirus is different from previous epidemics, as this has created a supply shock, one can nonetheless look at previous episodes to try and gauge how the markets will be perform over the next 12 months. As the table below, shows market returns have been strong post the initial correction in almost all of the previous epidemics. Historically, investor’s reaction to such epidemics and fast-moving diseases is often short-lived.
Whilst we do believe volatility will stay elevated for a period of time, with the negative economic impact from the Coronavirus still working its way through the global economy, panic selling now will result in realising losses today and missing the upside as most investors fail to pick the bottom. Times like this also provide an attractive opportunity to invest in great businesses benefitting from global megatrends.
Strong Central Bank Policy Response with fiscal stimulus to follow
The 50 bps cut by both the Federal Reserve in the United States and the UK central bank, and 25bps cut by the RBA, are aggressive responses in assisting in loosening financial conditions which is particularly important for the credit market at a time of heightened stress. The G7 members also gave their support, as shareholders, to the IMF and World Bank's decision to open credit lines and emergency facilities to lend to countries facing a cash crunch when dealing with the virus. "G7 Finance Ministers and Central Bank Governors stand ready to cooperate further on timely and effective measures,” the statement said.
This is now being followed up by fiscal stimulus with Rishi Sunak, the UK Chancellor of the Exchequer, unveiling the biggest public spending package on UK record as he pledges £600 billion to power "a decade of growth for everybody". Over the next five years, an average of £120 billion per year will be spent on roads, railways, broadband, housing and research, which Mr Sunak says is the highest real-terms public investment since records began in 1955. He also announced a package of measures to help the country get through the coronavirus crisis. If other governments were to follow the UK’s lead this provides great optimism for the long term which will be positive for equity markets in the years to come.
Advances in medical Technology
The world is in better shape to come up with a medical solution — a coronavirus drug or vaccine — than it’s ever been. Within a couple of weeks of discovering the outbreak, Chinese scientists sequenced the virus’s genome and shared it with the world. Only two days after Latin America’s first case of coronavirus was confirmed in São Paulo, the largest Brazilian city, researchers at Adolfo Lutz Institute (IAL), the University of São Paulo (USP) in Brazil and the University of Oxford in the UK have published the complete genome sequence for the virus. Pharmaceutical companies and research centres then began mobilizing and developing new ways to prevent and treat Covid-19. The viral genetics now hold the key to creating what could end this outbreak for good: vaccines and pharmaceutical treatments.
Importance of sticking to the long-term plan!
The current virus is clearly having a sharp negative short-term economic impact. History would suggest that even if this leads to a technical recession this normally lasts for a short period. Aggressive policy responses from governments and central banks will provide a cushion to the downside. The chart below highlights the number of crisis since the GFC and the significant opportunity cost if one panicked into selling their positions.
The recent pull back in equities has increased the attractiveness of equities, particularly quality growth stocks in a low growth environment. According to Strategas Research 95% of companies in the S&P 500 are now providing a dividend yield higher than the bond yield. Many of these companies will have growing cash flows leading to increasing dividends.
Critical to invest in the highest quality companies
Investing in quality stocks is critical from both meeting your investment and financial goals but also importantly maintaining your emotional volatility to not panic when others are doing so. Insync invest in the highest quality stocks for the simple reason that they outperform over the full investment cycle, and particularly during market downturns. It is important to define quality, and for Insync these are businesses with the highest levels of profitability, based on returns on invested capital, with a long run way of growth supported by megatrends. Research by Strategas Research showed that since the February 2020 high in stock markets, the highest ROIC and highest operating margin companies outperformed and the highest beta stocks, typically the most economically sensitive and often the highest leveraged companies, left portfolios exposed to the worst of the decline. This is consistent with past observations of more severe market downturns.
The Future is Bright!
Insync invests in some of the most profitable businesses benefitting from unstoppable and durable megatrends that are very large in size and growing much faster than global GDP. These companies are generating significant amounts of value through innovation and are on the right part of the megatrend s-curve. The volatility in markets is providing a good entry point into the winners of tomorrow for investors who have a longer than a 6-12 month view. The Insync strategy provides an important solution to assist investors meet their long term financial goals.
Disclaimer Equity Trustees Limited (“EQT”) (ABN 46 004 031 298), AFSL 240975, is the Responsible Entity for the Insync Global Quality Fund and the Insync Global Capital Aware Fund. EQT is a subsidiary of EQT Holdings Limited (ABN 22 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT). This information has been prepared by Insync Funds Management Pty Ltd (ABN 29 125 092 677, AFSL 322891) (“Insync”), to provide you with general information only. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither Insync, EQT nor any of its related parties, their employees or directors, provide and warranty of accuracy or reliability in relation to such information or accepts any liability to any person who relies on it. Past performance should not be taken as an indicator of future performance. You should obtain a copy of the Product Disclosure Statement before making a decision about whether to invest in this product.