Unless you’ve been living under a rock lately, you’ll know that the world has been gripped by a global disease outbreak dubbed COVID-19. A couple weeks ago, global markets started to react to the outbreak.
Why are markets tanking?*
For the most part – unfathomable stupidity. I genuinely believe that fear of the virus will cause significantly more economic harm than the virus itself. The RBA has a responsibility to tone down bad economic news to avoid causing mass hysteria. The media on the other hand has no such responsibility and it’s quickly becoming general consensus that the media is the indirect cause of the global sell-off. It’s not that markets shouldn’t react negatively to an issue of this magnitude, it’s that they’re acting on little-to-no information and therefore moving irrationally.
People aren’t going out as much, governments are cutting off global supply chains, freedom of movement is being heavily restricted and millennials are being discouraged from pursuing their smashed avo ambitions. Markets have entered bear positions (20% drop from recent highs) and many of my friends are asking whether a ‘buy the dip’ opportunity is about to present itself. The frustrating response I’m giving is what I think to be the most sensible one: nobody knows. As a general rule of thumb, it’s quite dangerous to try to time the market. It makes much more sense to instead look for a market trend over a longer period of time and make a smarter, more informed decision rather than a Trump-inspired one. On 25 February he tweeted that the “Stock Market [is] starting to look very good to me!” and on 29 February his son Eric tweeted that “In my opinion, it’s a great time to buy stocks or into your 401K. I would be all in… let’s see if I’m right…”. Today Trump sunk global markets. Thanks for the advice gents. We’ll stay tuned for the next brilliant investment tip from the Oracle of Fox News. In the meantime, here are a few things you should keep an eye on.
A safe-haven asset is something investors believe will retain its value (or even rise in value) during an economic downturn. These typically include precious metals such as gold, or long-term government bonds such as 10-year US treasury bonds. Well, a few days ago we received a very clear signal that investors had raised the alarm. 10-year US treasury bonds sank to their lowest yields on record. What does this mean?
You’ll recall that in Accumulating assets, we discussed that there’s an inverse relationship between bond prices and bond yields (i.e. as prices go up, yields come down (and vice versa)). You’ll also recall that in Economics 101 we discussed how high demand for an asset drove up its price. Record low bond yields indicate a boost in bond prices, which indicate high demand for bonds and that means the market is very clearly telling us that investors are pulling billions out of riskier assets such as shares and investing instead in safer assets such as long-term bonds. Bond yields have historically been a relatively good indicator of investor sentiment but times have changed and some investors are beginning to question just how useful an indicator they are today – more on that in a later article.
There’s fierce debate among investors as to the effects of the virus on residential real estate investment. Here in sunny Australia, investment in housing on the east coast of the country is typically seen as a safer investment. This is because cities like Sydney and Melbourne are seen as highly desirable cities to live in and as populations rise, so too do house prices (generally speaking). Housing is also a necessary good, rather than a luxury good. Even in times of economic crisis, people will always need shelter.
Global markets react to economic data. Most of the OECD countries, even if not directly impact by the coronavirus outbreak are forecasting significant decline in GDP (see Economics 101). Some countries, including Australia are forecasting negative GDP growth. Why is this bad? Well, as we also learned in Economics 101, two successive quarters of negative growth means you’re in recession territory. Consumer confidence plummets, unemployment rises, companies go into liquidation and businesses shut down. Keep a very close eye on what data the RBA releases over the next few months.
China’s Manufacturing PMI
There’s no denying that China is the manufacturing powerhouse of the world. Cheap labour and readily-available resources, as well as the country’s advantageous geographical positioning has made China the largest exporter of manufactured goods in the world. The Chinese Manufacturing Purchasers Managers’ Index (or PMI) measures the performance of the manufacturing sector and some investors believe it can forecast economic trends given how much global demand there is for Chinese manufactured goods. Last month, the PMI fell to its lowest level on record. China is insisting the virus is contained, or is close to being contained in the country, so it would be interesting to see how the PMI fluctuates over the next few months.
How are central bankers/governments reacting? Will this help?
You’ll recall in Economics 101, we noted that when the economy is under-performing (such as now), central bankers start to undertake expansionary monetary policy – that is, they start to lower the official cash rate. This makes credit cheaper. Mortgagors save interest on their home loans and have more discretionary money to spend (on something useful pls – not on birkenstocks) to (hopefully) stimulate the economy, businesses are able to borrow at cheaper rates so they’re incentivised to invest in and grow those businesses, and investors start to gather more confidence in the sharemarket because of all this new-found credit. You should understand however that central bankers have (in my opinion) been far too trigger-happy in the past with monetary policy and that they’re now left with little-to-no room to move with their prized cash rates. As a result, they may soon start undertaking ‘unconventional monetary policy’ measures – more on that in a later article.
What are governments doing? So many things. Many wrong things. Some right things. But so many wrong things. Once you know that containment is no longer an option (see below), shutting down trade, restricting freedom of travel and telling people to stay in their homes just causes mass panic and eventually collapses your economy. A balance needs to be struck between the economy and public health if it’s clear this thing isn’t going away anytime soon – as our governments are telling us is the case. What else are they doing? Spending. Like there’s no tomorrow. Governments all over the world are announcing stimulus packages to try to save suffering businesses and stir economic activity. Will it work? Time will tell.
What will make investors come to their senses?
There are two events which will make things go back to normal:
- Containment: If COVID-19 is successfully contained, investors will stop worrying so much and everything will be business as usual. Unfortunately, most health experts agree that containment is no longer an option.
- Vaccine/treatments: If scientists and medical specialists are able to develop a vaccine or effective treatments for the virus, people won’t be so concerned about catching it. The virus is generally well understood among scientists because this is not the first time we’re seeing a coronavirus outbreak. There are already a few pharmaceutical companies undergoing human trials.
* Markets also tanked on 9 March because Saudi Arabia and Russia began undertaking some serious phallic-region-measuring contests.