The problem now is how quickly economies can be opened-up again, ending the damage being done to the finances of individuals and businesses by social restrictions.

Reported new infections appear to be levelling off in developed economies. This now seems to be occurring in NY and California, two of the recent hot spots. European numbers seem generally to be going down. East Asian economies do not seem to be seeing numbers increasing again as a result of reductions in social restrictions. The two most important indicators, China and Korea, have had very low reported new infections for over a month. In emerging economies the numbers however are unknown.

A note on the new data

New infections are recorded as those testing positive, however, testing is not large-scale randomised testing of communities, it is largely those who present themselves for testing because they have symptoms. The virus is more widely distributed than the “infection numbers” indicate, it is just that some are unaware of infection because they have no symptoms or have symptoms are so mild that they don’t seek testing. Consequently, the mortality rate is lower (most probably far lower) than simply dividing the casualties by the reported infections.

It would also appear that the overcrowding of ICU units was at worst localised and temporary and is now dissipating. For instance, in NSW the number of Covid 19 patients in ICU is approximately 30 – a far cry from the hysteria that all 2,000 beds would be used by 6 April.

From an economic standpoint our view was that the critical factor was the time that economies would be restricted because that would determine that strain on the liquid assets of individuals and businesses. It would now seem that the more extreme time frames of six months or until a vaccine is produced is excessive. But it is probably too early to predict how long restrictions will last as it is in the hands of our political masters (if given free reign one would suspect that activity would now be picking up).

This has particular significance for the banking sector, where share prices have been particularly hard hit. We have put the view earlier that banks (in UK, US and Australia) went into the downturn with high levels of capital and strong lending books in stark contrast to the 2008 experience. If the winding back of restrictions starts to occur relatively soon we think that the discounts to tangible asset backing that they are trading on will prove excessive. We are expecting a further update prior to the banks half year announcements in a couple of weeks.

The Chinese economy is starting to grow again, with construction growing more than exports and consumer products. Cement volumes have picked up as have prices. Importantly for Australia, steel production is increasing and stockpiles of both iron ore and steel are decreasing. RIO and BHP are also benefitting from the supply issues of their major competitor, the Brazilian producer, Vale.

Manufacturing is one of the more mired sectors as a result of complex supply chains that have all to be re-started. The least effected in this are those with relatively few inputs and localised markets, such as James Hardie. Hopefully Boeing will be released from its 737Max grounding in the not too distant future (at least it won’t have an inventory problem), although its customers are in one of the hardest hit sectors.

It is difficult to identify any directly analogous situation which might provide some guide as to how events will unfold. Neither the 1987 or 2008 financial crises saw such a rapid and widespread decline in activity and employment. We have no real guide to how an economy that has been put in an induced coma will come out. One observation that we would make is that in the two instances mentioned above the financial systems were in awful condition. Lack of capacity to lend in the banking system is not part of the current problem.

The approach we propose taking is to hold sufficient cash to cover requirements during a period when dividends will be lowered or withheld and look for financially strong companies well placed in attractive industries that are selling at low or very low prices.

Kind Regards,

Hugh MacNally
Chairman
0455 455 277

 

p.s. The biggest casualty of the last three months has probably been the soothsayer. Predictions have been wildly inaccurate on both sides of the mark. Initially they were too low (ours included – perhaps comparisons with the 1918 influenza clouded the crystal) and then they were very much exaggerated. Even Byron Wien’s annual surprises are looking a bit below par this year – over a few decades Byron has had a pretty good batting average with some thoughtful predictions for the year ahead. The top ten are shown below for your interest.

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Byron Wien and Joe Zidle Announce Ten Surprises for 2020

New York, January 6, 2020

1. The economy disappoints the consensus forecast, but a recession is avoided. Federal Reserve Chair Powell lowers the Fed funds rate to 1%. Without a comprehensive trade deal in hand, President Trump exercises every executive authority he has to stimulate growth and ward off recession. He cuts payroll taxes to put more money in the hands of consumers.

2. Inequality and climate change become important election themes, but centrist ideas prevail. The House of Representatives sends articles of impeachment to the Senate, but Donald Trump is not convicted or removed from office. Enough information is revealed in the proceedings to cause some of his supporters, as well as many independents, to throw their support to liberal candidates in 2020 state races. The Democrats take the Senate in November.

3. There is no comprehensive Phase Two trade deal that limits China’s ability to acquire intellectual property.  National interests result in the balkanization of technology. The development of separate standards for 5G and other tech hardware proves to be bad news for the future of world economies. The move toward “decoupling” gains traction in negotiations with China.  US economic co-dependence with China erodes. Both China and the US keep their hands off Hong Kong and let the protest settle down by itself.

4. The prospect of a self-driving car is pushed further into the future.  A series of accidents with experimental vehicles causes a major manufacturer or technology company to issue a statement that it is no longer developing self-driving technology.

5. Emboldened by the pain of economic sanctions, Iran takes advantage of America’s unwillingness to intervene and steps up acts of hostility against Israel and Saudi Arabia. The Strait of Hormuz is closed and the price of oil (West Texas Intermediate) soars to over $70/barrel.

6. Even though some observers believe valuations are stretched, a surge in investor enthusiasm pushes the Standard & Poor’s 500 above 3500 at some point during the year. Earnings increase only 5%, and S&P 500 multiples remain elevated because monetary policy is easy and investors become more comfortable that intermediate interest rates will rise slowly.  Volatility increases and there are several market corrections greater than 5% throughout the year.

7. Big tech companies face growing political scrutiny and social blowback. Once the market leaders, certain FAANG stocks underperform and the equal-weighted S&P 500 outperforms. A proposal to break up the largest social media platforms and increase regulation and government oversight gains popularity.  This has greater success than prior government efforts against Apple, Microsoft and IBM, because it has widespread support from the American people.  A millennial in New York City puts a phone down and makes eye contact with another human and finds it non-threatening and refreshing.

8. Having secured a workable Brexit deal, the United Kingdom turns out to be the winner in its divorce from the European Union. The equity market rises and the pound rallies. The UK benefits from a long transition period, and growth exceeds 2% as foreign direct investment resumes now that the outlook is clarified. The EU economy remains soft, and European markets other than the UK underperform the US and Asia.

9. The bond bubble starts to leak, but negative rates continue abroad. Even though the US economy is slowing, the 10-year Treasury yield approaches 2.5% and the yield curve steepens. Japan and China pull away from the Treasury auctions. Rather than economic fundamentals or inflation, supply and demand drive yields higher.

10. The problems with Boeing’s 737 Max are fixed and deliveries begin.  The plane becomes a mainstay around the world, enabling airlines to operate more efficiently and increase profits. The stocks become market leaders.