April 06, 2020
April 06, 2020 | Adviser News
Economic update: COVID-19
Charles Stodart, Investment Specialist at Zurich Investments
Braced for (economic) impact?
Market volatility has pulled back from its recent highs as markets digest the impact of the eye-watering stimulus packages that have been put on the table by governments around the world. Well over 10% of GDP in announced economic assistance is not uncommon.
Locally, the ASX All Ordinaries advanced by nearly 5%, marking a rare divergence from the S&P500 in the US, which fell by a little over 2% for the week. A couple of factors may have supported the local market: a noticeable lag to global markets in the week prior and some early signs that Australia may be having relative success in ‘flattening the curve’.
Investors are assessing whether the staggering amount of support that has been announced, from central banks and governments, is sufficient to weather the economic dislocation that we are starting to see as containment measures bite on activity.
The speed of this dislocation was evident in the March US unemployment data which was released at the end of last week. The number of unemployed jumped by 701,000 and the unemployment rate rose to 4.4% from 3.5% (in February data). While this is a big move, it largely doesn’t take into account the 10 million in new jobless claims seen over the last 2 weeks*, which will be captured in the April numbers, due to be released in early May.
Downgrades in expectations for corporate earnings are also being more aggressively applied, particularly for the first and second quarters. Factset, a data provider for financial services, reported on 3 April that expectations for S&P 500 earnings have fallen to a 7% decline in the first quarter and 15% decline in the second. Earlier expectations of growth have been abandoned as economic activity slows, though given the lack of corporate guidance, expectations may have to be adjusted further.
Dividends are also likely to be cut as corporate earnings are squeezed. Goldman Sachs now forecasts a 25% decline in S&P500 dividends this year. Australia may experience a similar contraction, though it is of some comfort to investors that APRA will not force banks to suspend dividends, as bank regulators have done elsewhere.
Investors should also keep an eye on credit markets. Goldman Sachs estimates that over $500bn of bonds (in notional value) will be downgraded from Investment Grade to ‘High Yield’ over the next 6 months as corporate prospects are re-evaluated. This may create some ructions in the credit markets depending on investor mandates.
Given these developments, the market’s relatively steady performance over the last week suggests that investors are willing to ‘look through’ the impending economic dislocations to a fair degree – at least for now. Of course, the sharp fall in equities from their late February peak priced in a lot of bad news, and also reflected a dramatic change in sentiment. But given the extent of the expected dislocations (Goldman Sachs thinks that second quarter GDP growth in the US may fall by an ‘unfathomable’ 34% (vs the first quarter, annualised), recent market activity appears to reflect both respect for the announced support measures and a relatively sanguine view of the extent of the disruption.
While the initial fall was largely indiscriminate, a more measured market allows investors – and active managers - to consider which companies and business models are better placed to weather these coming dislocations. Where the proverbial baby has been thrown out with the bath water, opportunities may be emerging.
*US unemployment data is based on a survey that is carried out in the week that includes the 12th of the month. Thus data for the March survey was collected in the week starting Monday 9 March 2020.
Sources: FactSet, Goldman Sachs
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