The Current State of Play

Airlines were the first to be impacted during this crisis and are likely to be the last to get back to full operating capacity. I’d expect to see our states being slow to lift their “no travel” bans across borders and international travel being even slower to reignite. Why? Because looking at the COVID-19 maps, most infections originated from overseas travellers and it seems that the virus has not really spread to most of the developing world in a big way yet. When it does, their meagre health infrastructure will be totally inadequate to “flatten the curve”, no one will believe the reports on infection rates and local authorities will be very concerned about porous borders and the risk of a second wave of infection.

Can the airlines survive? Prudent capital raising and government support will likely ensure Qantas does. I would not be so confident about other domestic airlines or low-cost carrier models around the world.

On top of the developing world, the US is closer to a peak but its capitalist version of healthcare means it will likely suffer from a large number of unreported and untreated cases. Stories have emerged of US states bidding against each other for ventilators.  As for the President’s bold prediction of being open for business by Easter, I am reminded of The Castle. “How much does he want for the jousting sticks... tell him he’s dreaming.” Christmas might be closer to the truth.

Locally, the National Cabinet has done a good job of containing the spread and number of deaths from the virus, but runs the risk of making the cure worse than the disease. It is incredible that it was only at the very end of March that advice was issued for people over 70 and those with chronic health problems to self-isolate. Given the earlier evidence from China and Europe that this was where 90%+ of the high-risk cases occurred, it should have been one of the early measures adopted. (Always easy in hindsight).

The Federal Government’s $130b package of wage subsidies is almost beyond belief in its scale. As Macquarie Research point out if you exclude the mining and building sectors which continue to function relatively normally, it represents about half the national wages bill over the next 6 months. It will take many years of prudent fiscal management to repair this scale of budget damage. In total, support measures represent an almost unimaginable 15%+ of GDP. This is surely approaching the limit of what can be done by Government.

What is being done on the monetary policy front? The most recent RBA minutes indicate members had “no appetite for negative interest rates“.  While this is consistent with previous statements, it’s notable that the Board didn’t appear to have discussed purchases of corporate bonds.  Given the huge blow-out in spreads and the need for many Corporates to refinance, I expect the Bank may be forced into buying this type of debt directly.

Before we Get to the Other Side

Lessons need to be learned from the Spanish flu pandemic in 1919 which had 3 separate phases where the infection rates spiked. Clearly the lesson here is not to remove social distancing protocols or lockdown provisions too soon. The risk is the clear flattening of the curve we are currently seeing in Australia could be transitory.
 

Daily growth in confirmed COVID-19 cases in Australia in percentage terms

The counter to this is that Australians are not well known for being strict rule followers. If the overzealous policing of these lockdown conditions evidenced in recent news stories continues, or they drag on too long despite falling infection rates, cases of civil disobedience are likely to spike. There is also a serious risk that even if the lockdown measures are successful in curbing infection rates, they may cause increased deaths from other sources driven by isolation such as suicide and domestic violence. If so, the pressure to lift restrictions will intensify.

The most likely approach is a gradual lifting of restrictions as confidence increases that the person to person infections are under control. But don’t expect to be doing much overseas travel anytime soon.

Despite best efforts by government to use existing channels to distribute cash, it takes time to register recipients and get things rolling. The first cheques from the wage subsidy via the ‘JobKeeper Payment’ allowance for example are not due to go out until 1st May. Given the mass shutdown in many industries already underway, the “bridge” appears to have a large gap in it. Clearly many companies will find it very difficult to raise fresh debt finance to fill this one month wages gap despite staff ultimately being back paid until March.

Financial markets are beginning to stabilise as there is increased confidence that the virus is coming under control in most regions. While Australia and some other countries look favourable, events in the UK and US suggest a long road ahead. Consequently, volatility and large daily price swings are likely to continue for some weeks yet. A significant bad news event is very possible and would test current optimism that we have seen the bottom in markets.       

What about the “New Normal” on the other side of the crisis?

It is very likely companies will have learnt many lessons:

• It probably isn’t that smart to tie your business to a single lowest cost supply chain.
• After an initial rush back to offices because people will be so keen to get out of isolation, many business owners may wonder if they need to rent office space to accommodate 100%, 80% or even 60% of staff. It’s expensive and a lot of people seem to enjoy the flexibility of working from home and dodging the traffic.
• It may not be the best use of my expense budget to send staff to New York or London for a couple of meetings. Virtual meetings actually seem to work pretty well. (Damn, there goes my frequent flyer status!).

On a more macro level, the hollowing out in the economy is likely to be significant despite the stupendous support packages. GDP will bounce sharply from double digit falls in the first half of 2020, but some industries will lag significantly or may not recover at all. Cash and cash flow are king at present and will be for some time to come. This means highly leveraged companies, those with challenged business models based on low profit margins and those which will be late to “reboot” in the cycle are prime candidates for bankruptcy. Some of our biggest export industries including travel and education are potentially captured here. Your average parent of an overseas student is likely to say, “do I really want to pay $X,000 a year to have my son or daughter educated online by an Australian university?” If they find a better alternative, pre-crisis student numbers may not re-emerge.

Financial markets however are a very different story. History strongly suggests that during crisis periods where large amounts of liquidity are pumped into the system it tends to find its way into financial markets first before trickling down to the real economy. The current liquidity is far greater than anything which has been provided during any previous crisis in living memory.  For clients with cash on the sidelines, equities are likely to deliver very strong returns from current levels on a 2-3 year view. Because of huge differences in the recovery timelines for each industry however, active management is best placed to capitalise on this coming rally.

The team at Zurich Investments will continue to keep you informed with updates on the markets and our various fund performances, we’re organising updates directly from our fund managers on how they are managing the portfolios, and we’re looking at how we can help you help your clients get some clarity and understand the various government assistance measures as the situation evolves. And as always, you can continue to reach your Zurich BDMs via phone and virtual meetings.
 

Stay safe.
 

Regards,

Matthew Drennan