Davy update to private clients - 18th March 2020

It has barely been a week since our last note, and yet the world seems to have changed. The number of people infected with and dying from the Coronavirus (Covid-19) has risen sharply across Europe and the US. Governments around the world are shutting down social and business activity to limit the virus’ spread.  Markets are extrapolating these shutdowns into future economic damage and selling off at an unprecedented rate. Where does this leave our investment portfolios?

The Coronavirus (Covid-19)

We have now had more people infected with the virus, and more fatalities, outside China than in China. It is clearly a global health crisis. Following the Chinese example, several European countries, including Ireland, have enacted strict social distancing policies by shutting down schools and large gatherings and restricting international transport.  We know from China and South Korea that this extreme approach can halt the spread of the virus. The concerns are whether the same methods can be applied as effectively in western countries and what impact this will have on growth.

The economic impact – a recession?

Apart from anecdotal evidence from leisure and hospitality industries, it’s still too early to see much virus impact in the economic data. Although we did get a taste of what might be coming from recent Chinese data. Last weekend we saw that retail sales there in January / February fell by 20%, and industrial production by 13% - their worst numbers on record. Many forecasters have changed their views and now predict contraction across Europe and the US in coming months

Does this mean a recession?  By the technical definition – two consecutive quarters of negative growth – yes this is increasingly likely, depending on how long virus-constraint policies remain. More important than gross domestic product (GDP) numbers is what happens to jobs and businesses.  With a short shock of a few months, we may not see too many lay-offs and bankruptcies, and recovery will be fast. This is why new government and central bank policies will be key. Commentators have focused on interest rate cuts and quantitative easing, i.e. bond-buying.  But direct support for households and businesses will be crucial to prevent this health crisis from becoming an economic crisis.

The market impact – a bear market

The market is not waiting to see the economic data.  It has extrapolated the Chinese outcome into western corporates and sold their stocks and bonds at a record pace. Apart from the 1-day portfolio insurance crash of October 1987, this was the fastest bear market, i.e. a 20% price decline, of all time. The S&P 500 index in the US fell 26% in 3 weeks and the Euro Stoxx 50 index in Europe fell 34% in the same time. The VIX index, a measure of US stock market volatility, closed higher on Monday 16th than it did on any day in the 2008 financial crisis.

The financial impact – is my money safe?

Remembering the financial crisis, some investors are asking whether the banking system is in danger. The good news here is that banks are much better capitalised than before, have fewer bad loans, and the European Central Bank has already moved to provide liquidity to the system as well as subsidies for banks to lend to the real economy. 

Our investment view – time to sell?

Sometimes bear markets take months or even years to play out as the economic picture unfolds. This time, traders have already decided that there will be a full recession with higher unemployment and insolvencies, not just a technical one. The bear market has already happened. Therefore expectation of a recession is not a reason to sell stocks now. In fact, now that a significant market decline has already happened, our inclination is to increase equities from here. We must stress that we don’t know when the virus will peak and the economic stress will end.  Just that it will eventually peak and the economy will recover. Therefore in our discretionary portfolios, we are taking opportunity of this extreme situation to temporarily add equities. The market could of course fall further as the virus and economic data gets worse, so we are making our additions in stages. For advisory clients, if portfolio adjustments are being recommended, your adviser will contact you with relevant proposed changes in the context of your individual circumstances.