Crystal Wealth Newsroom

COVID-19 market volatility


There’s been an awful lot written about how COVID-19 has impacted the markets. You can probably find something written that supports any theory you have, so I’m not just going to add to the general crystal ball gazing.

What we can do, however, is look at the evidence we have so far, assess the impact to date, consider how that may set markets up for the next phase of recovery, and highlight the factors upon which a relatively full recovery is dependent.

How COVID-19 has affected the markets
In the immediate aftermath of COVID-19, we all know all major share market indices dropped sharply (35%+). What is less obvious is that recently the S&P500 index just climbed back past the 3000-mark for the first time since early March. This means up 35%+ from its lows but still around 11% off its February highs. Locally, the ASX200 is only up 27% from its low, still around 19% off the February high. Further, the market rises have been driven by large well-capitalised businesses (particularly technology stocks in the USA).

Clearly, we’re not back to where we were, because the economy is not back to where we were. Some individual businesses are going to be changed for a longer period and more permanently than others. A staggered re-opening of the economy means the recovery process is likely to be slower than otherwise possible.

We’re in the middle of a great shifting process. We are working out which businesses are going to have the balance sheet strength, the cash flow access and lines of finance (liquidity), as well as the ability to raise funds and the capital they need to last and cope with a severe shock to their earnings (longer-term solvency).

There will be companies that are going to default; there’ll be companies with weak credit ratings. There’ll be companies in the ‘high yield, high risk’ part of the market that might struggle to raise money. This includes businesses with unsustainable gearing to start with, so their cash flows will come under further stress. Inevitably there will be some casualties, so you need to be careful about which particular businesses you want to own.

That said, overall, the progress we’ve seen so far has been positive and for many ahead of original schedules (remembering no one has a rule book on how long a pandemic will last or resolve). The responses of central banks and governments to date have been excellent: fast and deep. The stimulus packages that have been introduced have created liquidity and have given markets a way back and backstop to keep functioning.

What’s happened in the markets so far?
The markets are certainly an interesting place to be currently, and you have to look for the nuances to get a real feel for what’s happening.

For example, buying the broad Australian index (which has a high representation of financials) has underperformed a basket of resource stocks, given financials haven’t moved much until recently.

Some industrial stocks have recovered well (e.g. Amcor, Brambles) as has healthcare (e.g. Sonic Healthcare, Cochlear). Communication services, utilities (e.g. APA Group, Transurban) and technology stocks have generally been doing okay (or booming: e.g. Microsoft, Google and Facebook) as well as key resources (e.g. BHP, RIO). Energy and other cyclical stocks (e.g. travel, leisure, retail), however, are looking for more positive economic news.

So if you’re looking at things from just an index point of view, you can be lulled into a false sense of security, thinking, “The market’s recovered. What’s the problem, everything must be okay again?”.

Of course, it’s not necessarily true that the total market’s recovered, it’s that a few large companies in that index have recovered (and short-sellers of key stocks have retreated); which makes a big difference. The rest that are more reflective of the broader economy have struggled, so it means you need to be careful about which part of the index and which part of the market you want to own.

Above all, it’s important through such sharp market movements not to extrapolate short-term views – both positive and negative – into long-term outcomes. Ultimately long-term valuations of a business will matter as the data becomes clearer.

What does the road to recovery look like?
There has been much talk of anything from a V-shaped recovery to a great depression based, of course, on incomplete and unknown data. Prospects of a V-shaped recovery are given hope because businesses are beginning to reopen, and the government here in Australia is very focused on opening the economy up again. Still, a quick ‘V’ would seem to be a very optimistic outcome.

Instead, we see probabilities weighted towards a slower, more U-shaped recovery as economic growth returns. It’ll take time, post-virus peak, for businesses to stand on their own two feet, workers to be re-engaged and consumers to spend again. And this assumes no ‘second wave’ of the virus that can’t be managed within current health system capacities.

With this backdrop, there’s still a great deal of uncertainty. We know the second quarter (and probably third quarter) economic figures will be bad – unemployment’s going to look bad, forecasted earnings per share are coming down, earnings guidance is non-existent in many cases – and we still need to see how businesses are going to adapt to the ‘new’ environment.

How will your investments be affected?
Most with investments in share or property markets understand the value of their investments can go up or down, and it’s a long-term play. This is key to ensuring you don’t make strategic decisions at the wrong point in time.

The focus right now is cash flow. When we look ahead at client portfolios, we want to have visibility on the next 12-18 months of projected cash needs. If we know we can meet ongoing cash flow from cash and other liquid reserves, we can control the timing of our investment decisions, rather than being forced into action by market volatility.

In the current market, we are assessing which companies have underlying business exposures we want post-crisis – the ones that are going to survive this economic uncertainty. We want the companies (for either equity or debt exposures) that have the liquidity and financial backing to last the course.

Ensuring you’re in a position where you’re not going to be a forced seller buys you portfolio flexibility, and you can make adjustments accordingly as markets present buying and selling opportunities along the way.

We believe it’s early days for any recovery and there will be opportunities still to buy decent businesses for the longer term. So if you’re a longer-term investor, these fluctuations will smooth out to some extent over time. If you’re focused on the short term, that is far more problematic in the current volatile environment, and you want to be planning well ahead of time for any funding needs.

The adage of diversity being critical is ringing very true this year, and I challenge anyone to make a definitive call on what the next six to twelve months looks like as we work through this crisis. Who would have predicted earlier this year a bank hybrid moving down and up 25% inside two months?

However, we do believe that the markets will offer quality investments at better entry points than we have seen for some time, and this is worthy of serious consideration.

The future outlook
The pace of the recovery, of course, depends on many variable factors. At present, the central banks are providing a safety net (liquidity) for a lot of activity in the debt markets, and they’re trying to keep interest rates low to help personal mortgage and business borrowing costs. This looks likely to continue for some time, particularly in the absence of inflation.

The length and extent of government support programs also come into the equation, of course. They’ve been quick off the mark here and in the US, but again, how long will they keep it up? We expect there will be more work to be done here as well.

Fundamentally, the pace and shape of the recovery will depend on how the pandemic plays out. Can we keep a lid on any further outbreaks? Can we navigate through it without having to shut down again? Will a vaccine be discovered ahead of time, or will we just live with the virus with altered social arrangements?

After that, you’re looking at other factors such as international borders reopening and people travelling again with some relative freedom. Consumer confidence will be an essential ingredient here, and that will be one of the final pieces of the jigsaw. But we are not there yet.

Investment strategies
If you’d like to discuss your investment strategy, or explore the possibilities of investing, Crystal Wealth is here to guide you through. Speak to Tim or one of the team today.

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