Historic Market Context
The ‘black swan’ event of the Coronavirus is bringing high risk of downside to the economic momentum globally, and therefore to corporate earnings in the short term. The magnitude of the downside risk is difficult to quantify at this stage, being dependent on how long and how severely the virus crisis is going to impact economic activity.
As a result of this fear and increased uncertainty, equity markets have significantly repriced globally from historically high valuations. However, it is worth considering this event in an historic context against other prominent market falls and the overall upward trajectory of share prices in the last thirty years.
Source: FactSet, S&P 500 as at March 2020. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Immediate Economic Outlook
The impact of the virus is undoubtedly globally significant in the short term, constituting both a supply and demand shock at the same time.
Beyond China’s growth figures, which will be particularly badly hit, supply chains and global GDP will also be severely impacted, with Europe likely to suffer more than the US. At the market level, investors could remain in fear mode for a while.
However, this downward pressure in economic momentum is likely to trigger sizeable and potentially globally synchronised policy responses in the next 6-9 months to ensure the world doesn’t dip into a recession.
Central banks are on stand-by to act in an even more accommodative manner (and have in some instances already started to act), should economic activity suffer too much from the pandemic fear. We are also likely to see sizeable fiscal policy responses across key economies. Both of these could trigger a positive market response.
Market Reaction
Markets are likely to remain in fear mode for several weeks. We predict 2020 will continue to be volatile given both the short-term headwinds to growth and earnings, and the likely supportive monetary and fiscal measures we might see.
There will therefore certainly be plenty for the short-term pessimists to focus on. Depending on risk appetite, the market may or may not be willing to look through the sizeable earnings downgrade risk and profit warnings coming up in Q1 and potentially Q2, possibly leading to the need to reduce 2020 estimates. In the coming months, it will be a period of hoping for economic activity to recover in the second half of the year.
We believe markets will bottom once evidence of policy response comes through, once pandemic threat eases (contagion risk plateauing, hopes of a vaccine fast-tracked to availability) and/or the short-term negative impact on economic and corporate activity is accounted for.
Conclusion
Short-term investors will focus on the earnings downgrades to come at quarterly results, but for long-term investors, we see this period as an opportunity to buy selected stocks at more favourable entry points than previously.
A clear focus on quality businesses with strong balance sheets, pricing power, high returns and sustainable business models helps withstand short-term downward pressure, while accessing the economic benefits of longer-term growth themes.
We have identified three megatrends which we believe are going to be driving market dynamics across a range of industries, long after the current share price slump has passed: Demographic Change; the Future of Technology; and Resource Scarcity.
These are mega-trends that will remain relevant on a multidecade perspective and we will therefore look to use this valuable time to seek out companies that are long-term beneficiaries of these themes at attractive valuations.