12 March 2020

Market update in light of the Coronavirus epidemic

The last few weeks have undoubtedly been unsettling for clients relative to what had been a prolonged period of calm in financial markets.


The spread of Covid-19 or Coronavirus seemed to catch markets by surprise and geopolitical events over the past week have exacerbated uncertainty in financial markets.
At JM Finn we know such events will pass in due course and that economic activity will pick up at some point in the future, it’s just a question of when. Yet, given the prevailing uncertainty caused by the spread of Coronavirus, it is difficult to know how long this period will endure. We continue to carefully monitor the situation and seek to take appropriate investment decisions to help achieve your long-term investment goals by focusing on quality, cash compounding companies.


Background
The spread of Coronavirus continues to escalate with over 100,000 confirmed cases and, sadly, over 4,000 confirmed deaths at the time of writing. Against this challenging backdrop, concerns for the global economy have escalated and this has reverberated throughout financial markets.


Market volatility has spiked sharply and investors have looked to reduce risk by seeking out more traditional safe haven assets. We have seen equity markets dip sharply whilst fixed income government bond yields have trended lower. In commodities, the price of gold has risen whereas the price of oil has fallen sharply to reflect rising expectations of a global recession.


What is the latest on Coronavirus?
Before delving into the latest data on Coronavirus, we should preface that still little is medically known about Coronavirus – there are considerably more questions than answers. As we write, officially there are 116,166 confirmed cases of Coronavirus of which c. 70% are within China. However, the true number of Coronavirus infections is likely to be higher because some people are close to asymptomatic - this partly explains why Coronavirus has managed to spread so quickly despite containment efforts to date.


The first cases of Coronavirus were identified in China in December 2019. Markets initially seemed little fazed by the outbreak as there were no secondary epicentres. Yet, that has quickly changed with major outbreaks outside China reported in South Korea, Iran and Italy. Now, as we write, every country within the European Union has confirmed infections of Coronavirus.


What are we doing to monitor Coronavirus?
From a data analysis perspective, we are carefully monitoring the official number of Coronavirus cases, the number of cases by country and, looking at the number of new infections versus the number of case outcomes. Financial markets are likely to react ahead of the total number of new cases falling to zero. Therefore, we believe the key metrics to keep in focus are:
 The number of new infections relative to new recoveries
 The ratio of recoveries versus deaths.


At the time of writing, there are more new cases being reported than new recoveries. This shows the virus is continuing to spread despite current containment methods – Italy has, as a result, taken unprecedented steps to quarantine the nation.


We are also closely monitoring the recovery and death rates to understand how this changes. Currently the death rate sits at 3.5% of total confirmed cases but taking out those people still diagnosed with Coronavirus (47,691); the death rate is higher at 5.9%. This however does not capture the time period difference between contracting the virus and either full recovery or passing.

Why has oil fallen sharply?


Market uncertainty, caused by the spread of Coronavirus has been exacerbated by the price war in the oil market between Saudi Arabia and Russia. It appears Russia is unwilling to reduce oil production as it is concerned about marginal oil supply from US shale players, who have been taking market share from Russia over the past few years. Russia has sought to push oil prices below the cost of production for US shale companies, so that it becomes uneconomical for the US players to drill, allowing Russia to take back market share. However, Saudi Arabia has thrown a spanner in the works. With Russia ignoring proposed OPEC+ production cuts, Saudi Arabia unexpectedly responded by ramping up oil production. Against a weakening global economy, higher oil production is expected to cause a global supply glut. This has caused Brent Crude oil price to plummet by 52% from c. $66

per barrel at the start of 2020 to c. $34 per barrel at the time of writing.


We are analysing the implications should the price of oil remain low for a protracted period of time. Can oil companies sustain their dividends? Continue with their buybacks programmes? Service their debt payments? For reference, our initial thoughts are that Shell and BP can hold their dividends to the end of this year assuming the oil price does not fall below current levels and that nothing further arises to specifically impact the performance of either company.


We may then need to think about second order implications – which companies provide support services to the oil companies and which financial institutions have high levels of debt exposure to the oil sector? Where from here?


Thankfully, international governments are aware of the social and economic risks of coronavirus and are announcing stimulus packages to help mitigate its impact. In the UK alone, we have just had the significant announcement of dual monetary and fiscal stimulus. The Bank of England has cut its base rate to 0.25%, is offering banks funding at this new rate (plus a fee) and has also loosened their capital buffer requirements.
Collectively, these measures should allow banks to continue to lend and support the UK economy in spite of any economic shocks caused by the coronavirus. Additionally the new Chancellor Rishi Sunak has announced a £12b fiscal stimulus, on top of the additional £18b earmarked for public spending, to support businesses that are likely to be impacted by the virus. Both the Bank of England and the UK government have indicated that they have further dry powder available, should conditions deteriorate further.


Though the situation remains uncertain and volatile, we are confident that an active approach to investment management is the right approach. We continue to actively monitor the Coronavirus outbreak and the responses from governments, central banks and companies alike and what financial impact this has on a range of asset classes. Our approach however remains steadfast, we will continue to focus on detailed fundamental analysis and look beyond headline-induced panic. At JM Finn, we remain committed to seeking to take appropriate investment decisions to achieve your long-term investment goals.