Economic Update - March Quarter 2020
As the coronavirus spread around the world, share markets reacted sharply and were driven by fear. Initially, most economists were expecting the coronavirus to be kept under control and have a similar impact to that of SARS. These expectations were quickly quashed as the virus spread faster and wider than expected. March seemed to be full of negative news of the virus’s impact and people started to panic. Markets don’t like uncertainty and the impact of the coronavirus was largely unknown, so fear led to massive swings in equity prices. At the height of the fear, we had swings of 12% in a day which is what you would expect in a year.
In April we have seen a stabilisation of equity markets with the ASX All Ordinaries index rallying 16% from its lows in March. However, the questions remain; will the rally last, and have we seen the bottom? There is no definitive answer to these questions, however, we can be certain that a higher than normal level of risk remains in equity investments, and this is likely to continue for at least 6 months. As time goes by, and more economic data is released, we will be able to build a more confident picture of the medium-term impact of the virus and the outlook for the economy.
In previous coronavirus updates, we have highlighted the need for economic stimulus and ways to effectively combat the virus as precursors for economies to move past the virus. We have certainly seen massive stimulus measures by governments around the world, and good progress is being made through isolation measures to control the spread of the virus. However, without a vaccine or effective treatment the virus remains an active risk. We cannot expect an economic recovery to occur until businesses can return to normal.
Over the last few weeks, the self-isolation measures have had a dramatic impact in Australia at reducing the spread of the virus. We are expecting that the federal and state governments will begin reducing restrictions earlier than first anticipated. If Australia can eliminate new cases of the virus completely, then we may see restrictions reduced considerably, however until there is a vaccine or effective treatment of the virus available, restrictions around travel and other higher-risk activities will remain.
Over the coming months, we will begin to see some economic results about the actual impact of the virus. Much of the expected economic downturn has been priced in to share prices, however, there is a real risk that equity markets will see further drops in the coming months. Forecasts are that we will see a 5% drop in global GDP and 10% in Australia. In comparison, the GFC saw global GDP drop by 0.5%.
We are also expecting reporting season to show the impact of the coronavirus on company earnings and dividends. NAB is the first of the big four banks to announce a dividend since the coronavirus outbreak, and it has been slashed from 83c at the same time last year to 30c on the back of revenue drops and increased costs associated with coronavirus. We expect similar results from the other banks. At the same time, we are seeing strong results from non-discretionary retailers and medical providers.
Resource companies like RIO and BHP are expected to benefit from government infrastructure spending if it occurs. To date the stimulus by governments around the world has been aimed at supporting workers and keeping business afloat. Once the virus has passed we expect the stimulus to switch to creating jobs. One way governments stimulate jobs is by spending on infrastructure such as roads and facilities.
This is a positive for Australia as we are a resources heavy economy. Companies that produce resources such as iron ore stand to benefit from the expected infrastructure spend.
Australia went into this crisis in a stronger position than most other countries. Our government debt levels were relatively low, and our unemployment was also low. Although our economy has a high proportion of services-based business in it, we also have a relatively high level of resources-based companies. This places us in a better position than countries like the UK which are close to 100% services. As such we see the Australian economy as being in a better position to ride out the virus and expect the Australian share market to outperform other equity markets. The Australian dollar that was initially sold off as the virus outbreak started is expected to strengthen against the US and European currencies.
One of the risks we face is that with all the government spending, inflation could move above target ranges. When governments spend, it puts more cash in the system and generally results in prices of goods and services to rise. We do not see this as a risk in the short term however because there is downward pressure on inflation due to the spike in unemployment expected due to companies going into hibernation while the virus is managed. Once the virus is contained and economies start to recover, inflation may well become an issue.
Australia went into this crisis in a stronger position than most other countries. Our government debt levels were relatively low, and our unemployment was also low. Although our economy has a high proportion of services-based business in it, we also have a relatively high level of resources-based companies. This places us in a better position than countries like the UK which are close to 100% services. As such we see the Australian economy as being in a better position to ride out the virus and expect the Australian share market to outperform other equity markets. The Australian dollar that was initially sold off as the virus outbreak started is expected to strengthen against the US and European currencies.
One of the risks we face is that with all the government spending, inflation could move above target ranges. When governments spend, it puts more cash in the system and generally results in prices of goods and services to rise. We do not see this as a risk in the short term however because there is downward pressure on inflation due to the spike in unemployment expected due to companies going into hibernation while the virus is managed. Once the virus is contained and economies start to recover, inflation may well become an issue.
In previous updates we have highlighted the forces that are expected to drive strong economic growth when we come out the other side of the virus crisis. Low-interest rates, low oil prices, government stimulus and pent up demand all point to a strong recovery. For this to occur however, the virus needs to be contained, and the likely scenario is that it will take 12 to 18 months before we can safely say we live in a COVID-19 free world. The longer it takes, the harder it will be to recover. As such we are not expecting an economic recovery to occur until the end of 2021 or early 2022, and the recession we will witness (6 months or more of economic contraction) may evolve into a depression (A depression is a recession that lasts three or more years). It will take massive government intervention to pull us out of the heavy recession, however, governments have indicated they will do whatever it takes to get us through. The likelihood of a depression is low, and we expect more government stimulus in the future to help avoid it.
When reviewing client’s portfolios and financial objectives, we take into consideration the above factors. As we have highlighted in previous updates, your portfolio is set up with risks like share prices falling in mind. We set it up with other investments like cash or bonds to help reduce the impact of this risk on your wealth. This is at the core of diversification and we have considered how your portfolio will function depending on the market environment. In periods like we have seen in the last month, your investments in cash and bonds will have continued to hold their value or even increased as share prices fell. By remaining invested in shares, you stand to benefit when prices recover.
Importantly, your portfolio is expected to deliver, even after the current volatility, a long-term return that will meet financial objectives. You will have worked with your Financial Adviser to understand how much risk you can take with your investments. That work will continue to hold you in good stead through difficult times like this.
General Advice Disclaimer: The information in this report is general advice only and does not take into account the financial circumstances, needs and objectives of any particular investor. Before acting on the general advice contained in this report, an investor should assess their own circumstances or seek advice from a financial adviser. Where applicable, the investor should obtain and consider a copy of the prospectus or other disclosure material relevant to the financial product before making any investment decision to acquire a financial product. It is important to note that the price or value of financial products go up and down and past performance is not an indicator of future performance.