Market Context Update - Coronavirus

General context


Yesterday the virus hit ‘Main Street USA’ if you will, with the NBA and MLB halting the season, Tom Hanks and his wife contracting it and now in quarantine, the Australian Grand Prix’s cancellation, Disneyland shutting, a New York State of Emergency, the travel ban between the US and Europe etc.

You name it.

We are now getting the profit warnings from business impacts of the coronavirus – overnight we had Broadcom, Adobe, Auckland Airport, Dufry (major duty-free retailer) and Adidas, but this list will explode in the coming weeks.

But surely the scariest thing to come in the weeks ahead will be the headlines reporting on the likely strained healthcare facilities endeavoring to cope with patient numbers.

Presumably at the current rate of growth, that is next week.

Fortunately, in Australia we have a terrific health system and for that we should be thankful.

In the ‘cycle of acceptance’ I would say that from an investment market standpoint we are past denial and anger and now at or through the point of ‘bargaining’ - ‘bargaining’ being the ‘hope’ that the bad thing that is coming won’t actually happen.

The next is depression and then finally acceptance.

We are getting through this.

Big picture


Right now, the key to everything is liquidity.

Cashflow.

Like the GFC, like the 1987 crash, liquidity is drying up.

Liquidity dries up in times like this because market participants fear they won’t get their capital back.

Again, the market has shifted in the space of a week from a focus on ‘return on capital’ to one fixated with ‘return of capital’.

Exacerbating matters, as I mentioned in Wednesday’s note, the world has splurged on debt in the last decade as a means to turbo-charge returns as interest rates have collapsed.

This is now a major concern for those that have extended credit on slim margin to companies, governments and individuals now faced with an historically acute cashflow crisis.

I can’t think of any time like this where people have been so restricted in their daily activity.

But now the good news.

Despite some individual share price falls in our portfolio, our wider portfolio recommendations have been defensive and liquid. Within our portfolios, we took the decision to make a tactical asset allocation change to move 10% underweight of our long-term target growth asset allocations in late January. Whilst we did not foresee the large-scale spread and impact of the virus on both markets and the economy, the decision was predicated on high valuations across the board which we believe has exacerbated the sell-off over the past three weeks.

Investors should have liquidity available to buy assets and our constituent portfolio components have largely avoided exposures to illiquid, high-risk asset classes like private equity, high-yield, private debt.

We are overweight defensive assets.

Overnight moves & where we are Friday


Another major red night.

Europe down 12-14% (it had about 2-3% to catch up from US selling the previous night, and the US down 9-11%.

Australia today (1030am Friday 13th) is down 7.5% which makes for a top to toe fall of -32% in under a month.

In Australia, equities have underperformed bonds by -35% in less than a month.

In credit markets, we are getting signs of panic.

Leveraged loan indices have lost -10% and are below the levels seen in 2016.

Signs of capitulation are emerging albeit it is incredibly difficult to precisely time a market bottom.

Safe haven assets such as gold and cryptocurrency were sold off last night and the NASDAQ underperformed the wider U.S equity market for the first time in the sell-off, indicating that investors are now selling their winners.

We are entering the revulsion stage, at least for the short term.

What we will do today


Precisely because our recommended portfolios are liquid and defensive, we are in the enviable position of being able to be proactive and to utilize our liquidity selectively.

Whether today marks the low or not, it’s my belief that we are nearing a low point in this sell off.

In a real world sense the negativity has only just begun, but markets price ahead of time.

If you take the view that this virus will prove an acute, but temporary phenomenon, and that you are able to avoid pockets of leverage misadventure, then this is a time to be picking up quality, liquid assets for the medium term in a sensible, diversified manner.

Today we have quite a bit of cash to deploy, but as an analogy, if we have 8 bullets in the gun, perhaps today we might consider expending 3-4 of them.

Opportunities


It is very important that where investors add risk, they add to in stocks that the market will want to own as it comes out the other side.

Companies with strong medium-term growth, no or minimal earnings risk where possible near term and with solid balance sheets or cashflows to protect debt will be preferred.

Companies that are increasingly interesting to us are as follows –

 

  • AFTERPAY (APT) has halved in a month, yet from an operating stand-point demonstrated at its most recent results that it was rapidly expanding its competitive edge in a manner not dissimilar to the strategy deployed by Amazon (AMZN).

  • ALTIUM (ALU) is a fascinating mid-cap software developer with leading market share in the market for design of printed circuit-boards (PCB’s). It has halved.

  • NEXTDC (NXT) – a leading Australia data-centre provider, NXT is well placed to benefit from the rise in data storage requirements as businesses and consumers shift to the cloud.

  • TELSTRA (TLS) – is a defensive cashflow beast and will see precious little impact on its business from this viral outbreak. Dividend yield is now 5.5% full-franked and the value of its infrastructure assets will have risen with the fall in bond yields.


These are just four names when in reality, the pullback is providing opportunity in many more.

We would single out each of Pendal (PDL) and Nufarm (NUF) at current levels with net cash balance sheets and low valuations.

PDL will be impacted by falling investment markets no doubt but has over 10% of its market value in cash and as a major UK funds management group will be well-placed to benefit from the highly expansionary British spending plans outlined in Wednesday’s Budget.

NUF should also stand to benefit from improved profitability as Australia recovers from its drought and as American farmers benefit from the major Chinese agricultural purchases included in the recent trade deal.

These are difficult times, and there will surely be lasting economic and corporate impacts from the coronavirus, however we do increasingly believe that the March pullback is beginning to open up the prospect for a more positive outlook in particular areas.

If you have any queries or would like to speak with us regarding the above please contact your Partners Wealth Group Advisor directly or on 1800 333 143.