April 20, 2020

Covid-19: Update on its Impact on Financial Markets – 20 April 2020

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What is R0 and why is it important?

R0 is a statistical representation that epidemiologists use to describe how an infectious disease spreads through a population. Put simply, the average sick person, in a totally receptive population, must be able to get at least one other person sick (R0 = 1) for the disease to spread. If a disease spreads to fewer than one person, on average, an outbreak can’t happen. So, all epidemics involve something with an R0 of more than 1. Seasonal flu, for example, has an R0 of around 1.2.

In Ireland, social distancing has helped suppress the spread of Covid-19 tremendously. Understanding the government’s focus on reducing the infection rate to below 1 is something akin to understanding compound interest in investment returns. Even slight changes, positive or negative, can have a huge multiplier effect. An infection rate   of, say, 1.5 would result in only circa 10,000 infected people after 20 days while an infection rate of 2.0 gives the scary number of over 2 million for the same time period. For the record, the Republic of Ireland’s first confirmed Covid-19 infection was found at the end of February and as of Sunday evening, 19th April the official confirmed infected is 15,251 after 50 days.

Open up the economy again or maintain the lockdown?

Without a consistent supply of reliable antibody testing, global leaders are now stuck with difficult decisions. Either wait for the vaccine to be developed and administered which could take a long time or gradually expose their local population to the virus at a rate that health services can deal with. Capacities in healthcare vary greatly between countries and mean that lockdowns will be lifted at different timescales in different countries with the economic impact varying widely. Third world countries had low standards of healthcare before Covid-19 arrived and are therefore likely to have the worst experience and possibly the greatest mortality rates globally.

Notwithstanding President Trump’s plan for a 3 phase reopening of the US economy it will still be left to each State Governor to decide on the timing of implementation. The US health leaders have been vocal against easing restrictions too soon without the reliability of adequate testing to trace how the disease may be spreading. This is an issues that health officials worldwide are facing due to the inconsistency of each manufacturers’ protocols and equipment. This means that several testing processes are in play that may result in difficulties to acquire a uniform supply chain per region or country. In turn, this will have a negative effect on the pace of future testing and results and will impact on the data to be interpreted before lockdown release decisions are made.

The net result of whatever medical decisions are taken is that global activity is not simply contracting, it is being deliberately frozen to save lives, primarily the elderly but also those far younger with pre-existing medical conditions. If a sharp economic rebound is to occur in the second half of the year job losses will need to be limited and corporate insolvencies will have to be at a far lower level than they are currently expected to be.

So how long can a lockdown last? While Communist China can exert its authoritarian power over its citizens without pushback, growing protests in the US are highlighting not only the loss of personal liberty but also the ongoing possible collapse of small businesses. Wuhan is now open for business and the total time spent in lockdown there was 16 weeks. There are growing signs that this is going to be roughly the same for Italy and Spain but being democratic countries, the risk of infection will continue to overshadow any slow return to what was normal.

The cost so far is an estimated €9 Trillion lost in global GDP. It is simply unsustainable for a multiple of this to apply if  it continued for months to come. To paraphrase Trump (and I wouldn’t normally) “The cure would then be more costly than the disease”.

Stockmarkets are bullish in the last 2 weeks. Why?

World markets finished last week at their highest in five weeks, in effect signalling that the worst effects of the pandemic would soon be over. This may be nothing less than a triumph of hope over reality as the problem that still remains is the valuations that are being used to justify such a recovery. For example, the S&P 500 is trading at over 20 times this year’s estimated earnings but this is before many companies report their first quarter results and expound on their outlook for the remainder of the year. Forecasts based on such statements are likely to go far lower with investors questioning why they are paying so much for earnings that are likely to keep shrinking.

All this being said, markets have always bought on the rumour and sold on the fact. As soon as today’s news is “less bad” than yesterdays, markets move upwards. This is happening now. It’s also worthwhile looking at other asset classes right now. Cash returns are negative and getting more so. Bond yields guarantee a loss if held to maturity at almost all points on the yield curve. Property is also lagging economic activity once again and so looks bearish for the next year or two.

That leaves one asset class – Equities, especially as investor cash will need to find a long term home. This wall of money will find its way into markets via stock buyback programmes just as it did at the end of the Global Financial Crisis 12 years ago. We don’t expect that the eventual result will be any different this time. All that will change is the exact timing and the volatility on a daily basis especially over the next few weeks.

Stay or Go?

Pandemics have happened in the past and, unfortunately, will probably recur in the future especially in a global economy and over time other political or economic events that impact stock markets will also occur. Warren Buffet has a famous turn of phrase that is relevant in the current climate “Be fearful when others are greedy and greedy when others are fearful”. Now is the time to consider getting greedy!

The most consistent route to avail of recent and further retrenchment is to apply a Euro Cost Averaging approach for monthly contributions to pension funds or invest large tranches in a phased manner. By investing “on the drip”, so to speak, we believe that sensible buying opportunities will emerge over the coming weeks. If you have surplus funds, consider investing some of this money to take advantage of current market instability.

Finally, if you are looking at long term personal pension funding, tax relief at 40% for pension contributions is another reason to buy into a 25% dip.

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