Governments and central banks have acted on coronavirus: is it time to buy?
The authorities are taking unprecedented measures to combat coronavirus. Are they enough? Are they too much? And what happens after the crisis is past? John Stepek looks at how to protect your portfolio.
Last week, politicians across the world promised to do “whatever it takes” to tackle the economic fallout from the coronavirus epidemic. Since then, they’ve gone above and beyond to meet that promise.
In the US – still the world’s most important economy and the one from which global markets take their lead – on Monday the Federal Reserve promised to spend as much as was required to buy an ever-widening range of assets in order to prevent financial markets from breaking down . By Wednesday morning politicians in the US had agreed a vast spending bill, worth more than $2trn, with various measures aimed at cushioning the blow for both workers and for shareholders.
Meanwhile, in the UK late last week Chancellor Rishi Sunak promised to pay 80% of the wage bills for staff that businesses would otherwise have laid off. He’s looking for a similar solution for the self-employed. And on Tuesday, Britain went into “lockdown” – joining many other European countries in imposing draconian limitations on the population’s right to move around and mingle, in order to contain the spread of the virus.
Have the authorities done enough?
Stockmarkets saw one of their biggest surges on record (more on that below) following the news from the Federal Reserve and the US government. Little wonder. As Andrew Hunter of Capital Economics points out, this deal is “more than double the size” of the 2009 stimulus that followed the financial crisis. It includes a “permanent fiscal expansion worth up to 5% of GDP”, including a handout of $1,200 per person, plus improved unemployment benefits, covering 100% of lost wages for four months. On top of that, along with the Fed’s new lending facilities, “up to $6trn in temporary financing” could be channelled to consumers and firms within months.
This is extraordinary and governments across the globe are following suit – as Sunak is fond of saying, the British state’s interventions are “unprecedented”. Even in the eurozone, where getting this sort of thing done is far more politically difficult, the European Union has officially freed member states to take any fiscal measures they consider necessary (they were already doing so, of course), while Germany has abandoned its attachment to balanced budgets in favour of propping up the economy.
The virus will still take a huge toll on the economy. As Hunter puts it: “none of this will prevent an unprecedented” – there’s that word again – “decline in GDP”. Indeed, Capital Economics reckons that US economic output could shrink at an unheard-of annualised rate of 40% in the second quarter, while unemployment could leap above 10%. However, the moves taken already “should help to foster an eventual recovery when the virus is brought under control”. And governments may take even further action.
In short, central banks (most importantly, the Fed) are underwriting the financial system, while governments are underwriting the “real” economy. The coming economic data will be disastrous and profits for many companies and sectors will be woeful or non-existent. There will be nasty surprises and unplugged gaps. But it now seems logical to conclude that the systemic risk – the risk of total collapse – posed by this crisis has been addressed. And although the damage may not as yet be easily quantified, its extent is becoming clearer and that in turn makes it easier for the market to price assets accordingly.
Have the authorities done too much?
As we’ve already said, we’re glad that decisive action has been taken – the government can’t decide to shut down a huge part of the economy then fail to step in to prevent the mass job losses that will result, or to cushion those who suffer most. Yet in the long run, these actions are likely to sow the seeds of the next challenge we face. This isn’t a traditional financial crisis – the closest comparison economically speaking is probably to a wartime economy. And there is an interesting parallel here.
Many argue that the deflationary environment of the 1930s was only truly brought to an end by the capacity destruction and massive government spending involved in World War II. Thankfully we aren’t at war – but there will be capacity destruction as a result of this and there will be massive government spending. That will have to be addressed somehow – and we doubt that after a thus-far uncertain period of confinement to quarters the population will be in any mood to embrace either higher taxes or public-service cuts. That leaves debt write-offs (a jubilee), or inflation, or a mix of both.
Inflation is usually a popular solution to getting rid of debt and it does seem like a logical outcome. As professor Tim Congdon of the Institute of International Monetary Research at the University of Buckingham points out, in late 1918, following World War I, in the US the consumer price index rose by just under 21%. There was a similar leap in spring 1947. Again, Congdon is not opposed to underwriting the economy: “the stresses of the next few weeks and months will be easier to bear if people can be confident about a more buoyant prospect in 2021 and 2022”. However, these “ultra-supportive measures” are – within about 18 months or so – likely to “cause significant or even major increases in inflation”.
As George Cooper of Equitile Investments puts it, “the Covid-19 crisis measures will inflict such massive damage” on the economy and government finances “that there will be no practical alternative to monetised deficit spending for years to come... At first the demand shock may make this crisis appear deflationary; however, over the coming years and decades we think the political consequences will mean it morphs into an inflationary problem.” Even uber-deflationist Albert Edwards of Societe Generale has noted that his “Ice Age” thesis (his long held and thus far directionally correct theory that US government bond yields would eventually collapse into negative territory alongside other developed government bond yields) might now be close to its sell-by date, with governments acting more rapidly than he expected to lend massive fiscal support for the economy.
Are we near the bottom yet?
The long term is important. But we also realise that while a lot of readers will be worrying about the damage already done to their portfolios, others will be feeling panicky about the prospect of missing out on gains if shares rebound sharply. So here’s the big question: have we seen the bottom yet? On Tuesday, the FTSE 100 jumped 9% – its second-biggest one-day percentage rise on record – while the S&P 500 saw a similar rise to record its tenth biggest single-day rise ever. That seems bullish – until you look back at the S&P’s other nine record highs. Two came in October 2008.
As you may recall, neither of those were anywhere near the eventual bottom for the market (which came in March 2009). Almost all of the others (with the exception of a bounce near the start of World War II) occurred during the early years of the Great Depression. It’s also worth remembering that while the authorities have now pulled all the stops out, the Fed first launched quantitative easing in November 2008. Radical action does not necessarily spell an end to the slide. In short, record surges go hand in hand with record falls and are more reflective of volatile, jittery markets rather than of a bottom.
If you are very keen to time the bottom, potentially more useful indicators to watch include the copper price. This crashed hard in the last week or so, but is now meandering around lows last seen in early 2016. China’s gradual return to work may put a floor under demand for the metal and as the rest of the global economy starts to perk up, consumption will rise too. Thus a recovery should show up in the copper price ahead of most indicators.
The oil price is also worth watching. Oil is being hammered by a combination of oversupply (Saudi Arabia and Russia are pumping as much as they can to put US shale producers – and each other – out of business) and by the slide in demand driven by the shutdown. While a low oil price would normally be good news for consumers, they aren’t currently driving anywhere. In this case, an ongoing oil-price slide is more of a risk to financial markets due to the impact on emerging markets. So if these key commodities can find a bottom then it would indicate that the market is almost certainly past the worst. And of course, we need to see signs that the pandemic is passing in Europe and the US before we can have visibility on what happens next – though we suspect markets will have bottomed before this happens.
Having said all this, looking to invest at the bottom is not the goal. Instead, you want to buy desirable assets when they are on sale. If they get a bit cheaper in the short run, it really doesn’t matter. And the current message from many of the smartest investors around boils down to: what are you waiting for?
As acclaimed distressed debt investor Howard Marks of Oaktree Capital puts it: “Given the price drops and selling we’ve seen so far, I believe this is a good time to invest, although of course it may prove not to have been the best time… But is there really an argument for not investing at all? In my opinion, the fact that we’re not necessarily at ‘the bottom’ isn’t such an argument”.
Meanwhile, in his latest Popular Delusions newsletter, Dylan Grice of Calderwood Capital argues that “now is the time to put the investment research you’ve done in past months, quarters and years into practice. So go steel yourself and buy something”.
So what should you invest in?
One indicator of how extreme sentiment had become this week is that investment trust discounts (the gap between the value of the trust and that of its underlying portfolio) blew wide open – on 23 March the average discount was 18.4%, notes Interactive Investor. That was wider than during the worst of the 2008 financial crisis. David Stevenson looks at some options on page 22 – but one play for those looking for yield, highlighted by broker Numis, is renewable group Bluefield Solar Income (LSE: BSIF). It now trades on a discount of 10% (having traded at double-digit premiums for most of 2019) and yields around 7%.
If you fancy being contrarian and investing in the hardest-hit parts of the high street (as opposed to beneficiaries such as the supermarkets), I would focus on the best-run names and likely survivors. For me, one example has to be clothing chain Next (LSE: NXT) (which I own). The share price has near-halved to levels last seen in the post-Brexit panic. But at its most recent results Next said it could “comfortably sustain” itself even in a worst-case scenario based on a £1bn slide in sales caused by a three-month shutdown.
If you are concerned about inflation in the long run then gold is the option we always suggest. But if and when inflation does return, oil is likely to be involved. The majors BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) have jumped from their absolute lows, but still look cheap. Don’t bank on the yields necessarily being paid, but on a long-run view they still look cheap today.