Here are my thoughts given the continued rout in equity markets over the last two weeks. In the West equity markets have fallen more than I thought they would but in China the reaction has, hitherto, been more muted and if anything a little less dramatic than one could have anticipated.
My initial thoughts, published on February 28th, were based on the following assertions:
- the virus impact would be ephemeral (regardless of how impactful it became in the short term).
- that China had already started to see a slowing in the number of cases.
- that the authorities would flood the system with liquidity.
- the Chinese and Hong Kong markets had already started to outperform as they were (and still are) further along in dealing with the issue.
In market terms things have moved on meaningfully since then such that all major stock markets barring China have fallen by over 20% and in some circumstances by over 30%.
I also added that as I had no idea where the bottom would be I would add in small increments to equities. That I have done, making several trades on separate dates as the market fell.
It is precisely for times like these that I kept cash in the portfolios. My aim is to raise equity weightings on all portfolio strategies to their maximum levels for the first time in several years as nothing that has developed thus far has led me to meaningfully change any of the above assumptions. The biggest thing that has changed is sentiment in the Western World as the virus arrived closer to home.
China has not had an easier time of it economically during their containment of the virus so my buying is not based on blind optimism. As previously stated Macau Casinos and the automobile sector saw declines of 80-90% and general factory activity collapsed. The Services PMI fell to an unprecedentedly low level of 26 (50 demarks expansion versus contraction). However, as the chart below depicting air pollution (a good proxy for industrial activity) shows, China is already coming back on stream. I mentioned this in my trip notes from the US last week and many more companies have corroborated the fact.
In Fact, today the Chine Medical Authorities made the following proclamation;
So goes China will go the rest of the world, with a lag. Indeed this lag will vary depending on action taken.
The amount of liquidity measures that have been taken have, if anything exceeded my expectations. Each of the People’s Bank of China, ECB, Bank of England and Federal Reserve have injected money into the financial system and made it easier and cheaper for banks to lend to small and medium sized businesses. This will enable more to survive the inevitable stresses being put on them by the anti virus measures.
You can see from the chart below what a relative sea of calm Chinese equities have been despite their own economic ructions.
In my opinion Chinese shares have held up better as investors feel more confident that the authorities have taken the necessary steps to control the virus and that once this occurs economic recovery is inevitable. From here there is more danger the rest of the world has a short term impact on China’s recovery rather than China dragging down the rest of the world.
If Europe and the US take as long as Hubei Province to contain the spread then that will be two months from now, excluding any help from seasonality (warmer weather). The more drastic the near term steps taken, the quicker the recovery. Central Banks and Governments have made it abundantly clear they will do whatever it takes to calm markets and ensure an economic rebound.
For example the Federal Reserve injected over US$1.6 trillion into the system after cutting rates the prior week while the ECB are buying an extra 120 billion Euros of bonds and lending to banks at 0.75%. The UK did its biggest fiscal package since 1992 in tandem with interest rate cuts and support for bank lending.
As soon as the recovery looks likely investors will start looking at ‘normalised earnings’ (what they expect profits to be when the economy/industry returns to trend) rather than the low near term numbers. This is what nearly always happens in such rebound scenarios with 2009 and indeed 2018 being prime examples of such moves.
In January and February 2009 we took cash down to 3% even as equities fell a further 20% from the beginning of the year. We then fully enjoyed the rebound as they finished the year up over 20% as the effects of policy kicked in. The rebound in profits did not happen until 2010. Given many companies now trade on very low normalised multiples, most of our managers have a bias towards strongly capitalised companies with strong cash flows, economic policy response has been robust and the virus will prove ephemeral, I am confident we will see a meaningful recovery as the Spring progresses.
As John Maynard Keynes said “It is largely the fluctuations which throw up the bargains and the uncertainty due to the fluctuations which prevents other people from taking advantage of them”.