COVID19 – THE FINANCIAL EFFECT

Coming to terms with the coronavirus

When markets fluctuate, helping clients stick with the plan you’ve laid out becomes more important than ever.

To help you manage through the current environment, I wanted to share some key facts and how Vanguard is viewing the markets and the economy.

Where are we right now?

The next several weeks will be crucial in determining the full effect that the coronavirus might have on the global economy.

Vanguard believes that if cases outside of China crest by April a timetable similar to China’s for reaching the peak of infections the United States can avoid recession.

Vanguard now views the odds of a U.S. and Australian recession in 2020 at 50/50.

Yes – it’s volatile, yet the financial system remains strong

Uncertainty around the coronavirus and its potential effects on the global economy have sent equity and some commodities markets into what seems like a free fall, with trading on the New York Stock Exchange temporarily halted twice this week after the Standard & Poor’s 500 Index fell more than 7%.

Asia-Pacific markets were not immune to this downturn, with equities selling off more than 5% on average early this week. Australian equities, in particular, experienced their worst daily decline since the Global Financial Crisis, with the ASX 200 dropping over 7% on Monday and Thursday.

As worrisome as the deep and rapid fall in equity prices has been, it’s important to understand that, unlike during the global financial crisis, the underlying structures of the global financial system are strong.

The global financial crisis was exacerbated by compromised underlying factors within the financial system that required a structural realignment of markets. Such a dynamic isn’t in play with the coronavirus, recovery from which is more likely akin to that of a disaster-relief effort.

Pricing in the impact of COVID-19

Vanguard believes the markets are watching for the crest of global coronavirus infections so they can price in the potential impact with confidence.

Only when valid health data makes it clear that we’ve reached the peak in new cases of COVID-19 (the disease that the coronavirus causes) can the markets determine whether they’ve reacted appropriately to the crisis or overreacted.

The plunge in oil prices makes it more complicated

Benchmark crude-oil prices were down by more than 20% at one point on Monday 9 March as the market faces both a demand shock from the coronavirus as well as a potential supply shock from the fraying of an alliance between Russia and the Organization of the Petroleum Exporting Countries that had helped limit production.

Vanguard believes the resulting lower oil prices could eventually provide a modest economic boost amid recovery from the effects of the coronavirus, especially in the Asia-Pacific region (including Australia) where most countries are net oil importers. To the extent that lower oil prices cascade through to the prices of other oil substitutes (for example, natural gas and coal), however, this could have broader negative-terms-of trade impact for commodity exporters like Australia and negate the potential savings from lower oil prices.

The market is reacting as we would expect given a more challenging outlook

Rising bond prices (as yields fall) are helping to offset falling equity prices in balanced portfolios. We would expect the markets’ long-term dynamics of rising equity prices and falling bond prices (as yields increase) to hold during an eventual equity market rebound.

We believe it’s not out of the question that U.S. Treasury rates could fall below 0%. This will have ramifications for global yields, including that of Australia which has seen yields tumble to less than 1% in recent days.

The Fed is likely to react to data, including those from the financial markets, in setting interest rates at its March 18 policy-setting meeting. Should recent conditions persist, we see the Fed as likely to cut rates. We expect developed market governments around the world to carefully monitor the situation and consider new fiscal measures to address the coronavirus and related challenges.

A focus on Australia

The Australian economy was already in a rather fragile position post the recent bushfires, which we estimated to have shaved off around 0.2 per cent of GDP.

The coronavirus outbreak is likely to increase this vulnerability, with slower-than-expected Chinese business resumption and Australian government containment efforts hurting certain key sectors like tourism, education and commodity-oriented firms.

The Federal Government’s announcement of an almost A$18 billion (~1.0% of GDP) stimulus package (not including the A$2.4bn and additional spending used to support the public healthcare system) is designed to cushion the economy from the effects of the virus.

Much of this fiscal relief will be targeted in nature, including making cash payments to small businesses and expanding asset write-offs for firms. For the government, this will mean temporarily putting aside its commitment towards achieving a budget surplus by 2020.

By front-loading these payments to Q2, the government hopes that spending activity will increase by enough to avoid a second consecutive negative GDP growth result in the first half of this year.

Merely providing payments to businesses and households might not prove to be enough. Recipients will need to have the confidence to spend their payments on goods and services, rather than add to precautionary savings or debt repayment. This might also be the reason why financial markets gapped lower on the open on Thursday 12 March despite the government’s announcement in the morning.

Will Australia avoid a recession?

Should the number of coronavirus cases peak by April, a scenario by which we place a 50% probability on, Australia has a better chance of escaping (though barely) a technical recession.

However, if things deteriorate for the worse, and if government’s containment efforts become even more aggressive, we see a non-negligible risk of Australia entering into its first recession in over 20 years. In this scenario, the negative impacts will not only be felt in tourism, education and trade-oriented sectors, but could reverberate throughout the domestic economy.

Staying the course

As ever, we hold to our Principles for Investing Success. Discipline, especially, is essential in times such as these.

Investors who abandon their well-considered, long-term financial plan rather than staying the course through a recovery could cause themselves lasting harm.

Investors mostly have experienced gains for the last decade; it’s important to remember that equity markets are filled with ups and downs, but have rewarded investors over the long term.

Advice matters.

Kind regards

Rebecca Pope
Head of Intermediary
Vanguard Investments Australia

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