COVID–19: Dealing with uncertainty and ongoing financial implications - MGD
10 March 2020

John Barton

Director and - Chief Executive Officer

We’re all becoming accustomed to our daily (perhaps hourly) Coronavirus (COVID-19) updates. As we come to terms with the human and economic dimensions of this infection, and the increased uncertainty inherent in the situation, it is no surprise that we see a range of impacts in the real economy and financial markets.

The spread of COVID-19, and the ongoing uncertainty of its repercussions, have contributed to the falls in equity markets we have seen in recent days. However, it is important to note that defensive assets (and therefore diversified portfolios) have performed as expected; protected by cash, bonds and, to varying extents, other asset classes such as property, currency and alternative assets.

 

Healthcare system impacts and challenges

COVID-19 presents significant challenges to health authorities. It is a relatively infectious pathogen which presents as a mild condition in most people, but which can lead to serious complications or death among a small proportion of the population (including those with existing medical conditions or otherwise compromised immune systems).1 Persons infected with COVID-19 may also remain asymptomatic for up to two-weeks, increasing their chances of spreading the virus.

The primary goal of mitigation strategies globally is to slow the spread of COVID-19 so that the peak load of infections is both delayed (to minimise the risk of overwhelming health systems) and much lower in total (minimising the total human and economic cost).

 

FIGURE 1. Goals of community mitigation for pandemic influenza2

 

As expected, some countries are successfully mitigating infection rates, while others are struggling for various reasons. Australia, with its relatively early intervention and first world healthcare system, is among the most effective in minimising infections and serious health consequences. We can, however, be sure that many countries which have not intervened early enough and/ or do not have the capacity for effective mitigation will not fare as well.

Whilst Australia’s experience of infection is likely to mirror the ‘shaded area’ (in Figure 1), from an economic viewpoint, we may not be so lucky. Already, risk avoidance is taking hold in Australia, as seen with consumer responses to the hoarding of basic necessities via ‘panic-buying’ and the selloff in local equity markets. Increasingly, people are beginning to take measures to reduce their exposure to potential infection by lowering their level of community engagement.3

 

Existing and potential economic and financial market impacts

Of course, reduced activity means reduced demand, increasing the likelihood of recession, an outcome not seriously contemplated in Australia since the height of the Global Financial Crisis (GFC).

Further, as a trading nation, Australia is particularly reliant on our export partners buying the goods and services we produce. As global demand is impacted, we are faced with the unusual circumstances of both a demand and supply shock to the economy. We are also concerned about potential second and third-order supply chain impacts permeating through the economy.

The bottom line, in terms of our local economy, is likely to be a significant drop in discretionary spending. Cash is now (as always) our guardian against worse times ahead and we collectively respond to these uncertain times by hoarding cash (to the extent possible) and reducing spending in discretionary areas. Of course, this individual risk aversion behaviour is, to a large extent, self-fulfilling and will contribute to the slowdown.

Additionally, we remain an economy of high-leverage, particularly at the household level. This has the potential to make matters worse should a downturn take hold to the extent that businesses (via reduced demand) and consumers (via lay-offs and/ or reduced hours) begin to experience material cash flow stress. Impacts to this degree do not seem likely at this stage, but nor can they be completely discounted.

Already the RBA and the Fed have cut interest rates. Whilst not unhelpful, these moves are unlikely to be overly effective as interest rates were already very low. Increasingly, we are now seeing negative interest rates in global bond markets and overnight we saw 10-year U.S. Treasury Notes offering a yield of just 0.5% p.a. (meaning $10,000 invested would yield $50 per year, before inflation!).

All eyes are on the Federal Government to coordinate Australia’s response to mitigate both a potential public health crisis and a potential recession. The government’s challenge is that while it can conceivably succeed in mitigating the COVID-19 infection, it is far less clear how (or if) it will be effective in tackling the ongoing economic impacts when Australia is so reliant on our international trading partners. During the GFC, for example, China’s demand helped save us from recession. What will happen this time with China still trying to get its factories going again (a process which is now underway, but will likely take weeks at best for anything close to full production capacity to be achieved)?4

Of course, Australia continues to enjoy a number of material advantages to assist it through these challenges (including the relative strength of our resource export sector). A related advantage oft overlooked is the Aussie dollar – which is now trading around US$0.65. At this level (and lower) our exporters (including our Universities who are currently experiencing peak impact via ongoing travel bans) are increasingly competitive, which in turn is positive for domestic GDP and sustainability of government revenues (i.e. tax receipts).

Summing up, it looks like we are rapidly entering a period (hopefully short-term) of supply and demand challenges which has the potential, but for coordinated government intervention, to morph into a period of economic and financial dislocation, impacting markets and peace-of-mind for investors for some months to come.

 

Now for the Good News

The last time the world faced synchronised economic recession, the leading economies – the G20 (as it became at the time) – developed a series of coordinated fiscal policies with the intent of minimising the real-world impacts of the global recession triggered by the GFC. And, that intervention worked! In March 2009, the world’s share markets started a recovery which subsequently became the longest bull run in history.

We can now expect the leading economies to again intervene and provide a fiscal response to COVID-19. Hong Kong has already provided cash handouts and subsidies to businesses in impacted sectors and to low-income families5, the Australian Government will announce its fiscal response this week6, and the World Bank has announced a USD $12 billion support package for low and middle-income countries.

Our clients know that we advise and implement portfolios using a goals-based approach. We construct your portfolio to meet your financial goals and objectives.

Our goals-based portfolio structure means that you have enough cash to get through an economic or financial crisis and not be a forced seller of portfolio assets. Those around you may panic sell and turn a paper loss into a real loss.

We can help you right now in a number of ways by:

1. Reassuring you that your portfolio structure is resilient and will allow you to meet your financial goals;
2. Meeting with you, in person, phone or video, as part of ad-hoc or scheduled reviews to discuss any changes to your objectives and the specific structure of your portfolio to meet those objectives; and
3. For those holding excess cash, or an overweight position in defensive investments, advising you in relation to taking advantage of market falls to increase your exposure to growth assets.

As our client, we know your portfolio is resilient in the current crisis. Our team of experienced advisers are here to help.

 

Disclaimer: This article contains general information only and is not intended to constitute financial product advice. Any information provided or conclusions made, whether express or implied, do not take into account the investment objectives, financial situation and particular needs of an investor. It should not be relied upon as a substitute for professional advice.

 

1 Australian Government Department of Health. (2020). Coronavirus disease (COVID-19). Retrieved from https://www.health.gov.au/sites/default/files/documents/2020/03/coronavirus-covid-19-information-for-close-contacts-of-a-confirmed-case.pdf
2 Centers for Disease Control and Prevention. (2007). Interim Pre-pandemic Planning Guidance: Community Strategy for Pandemic Influenza. Retrieved from https://www.cdc.gov/flu/pandemic-resources/pdf/community_mitigation-sm.pdf
3 ABC News. (2020). Coronavirus COVID-19 pandemic phase will call for ‘extreme measures’, Victorian Premier Daniel Andrews says. Retrieved from https://www.abc.net.au/news/2020-03-10/victorian-premier-daniel-andrews-on-coronavirus-pandemic-plans/12042780
4 AFP. (2020). One worker at a time, virus-hit China’s factories sputter back online. Retrieved from https://www.bangkokpost.com/world/1869154/one-worker-at-a-time-virus-hit-chinas-factories-sputter-back-online
5 AFP, Hong Kong. (2020). Hong Kong unveils cash handouts as COVID-19 deepens economic woes. Retrieved from https://www.deccanherald.com/international/us-in-process-of-bringing-air-defense-systems-into-iran-head-of-us-central-command-812538.html
6 Prime Minister of Australia. (2020). Speech, AFR Business Summit – Sydney, NSW. Retrieved from https://www.pm.gov.au/media/speech-afr-business-summit-sydney-nsw