17 Mar Economic and Financial Market Update as at 17th March
Written by David Graham, Senior Financial Planner, Mapp Fin CIMA® CFP®
The U S share market closes, this morning at levels past seen on Christmas eve 2018. As at the close yesterday, the Australian share market was back at levels last seen in 2016. The speed of the fall in share prices has been nothing short of epic. This has no doubt been enhanced by the ability of investors to buy or sell at the push of a button. We have no short-term idea about where this goes or how long it persists. Current conditions are not consistent with the various ‘corrections’ we have seen over the past 10 years. When we talk to you about risk profiles, this is the 1 in 20 year event to which we are alluding.
Confidence has been decimated by the inability of financial markets to price the global health emergency we are experiencing. Until some clarity arises in this regard, markets will react to the short term news-cycle. If you have never experienced this before, this is what a ‘bear market’ looks like.
It seems apparent to anyone you ask that recession, however defined, is likely. By definition a recession is a contraction in economic growth. The reduced activity you see every day (expect perhaps in the supermarket), is an obvious example. As businesses close down to manage the health risks, this is also a contraction of economic activity. The positive feedback loop the conditions create send these contractionary impulses through the economy. The figures proving a contraction are generally not published until months after the end of the quarter, but that ‘vibe’ you are feeling; that is the feeling of economic contraction.
The effects of a recession are not evenly dispersed. Some will feel it more keenly than others. Those whose job is at risk or were otherwise generally at risk will feel it the most.
Markets are trying to establish the extent of this contraction and how that looks in terms of the effect on company earnings. This is how markets price an asset – the current value of future cashflows. Current market conditions are suggesting a severe and extended effect on earnings, thus, they are discounting heavily. The real risk is where companies do not have sufficient balance sheet strength to see it through. Like in 2008/09, strong companies will be bruised, but not beaten. Weaker companies will not survive.
Our ‘average’ client has about 50% of their investments in equity type assets; risk assets, as we call them. Some have more, some have less. Thus, the effects on your portfolio will reflect this weighting. By and large the defensive assets, those that were generating modest interest income and little or no growth, are doing the primary job for which they are intended; capital stability. In normal times it is easy to dismiss this part of your portfolio as ‘lazy money’. Well, it is working hard now.
In these conditions, it is completely rational to be concerned. We are also concerned, but perhaps for different reasons. Our biggest fear, in this environment is that the pressure gets too much for you and you decide to ‘bail out’ of growth assets. It is like you just want that gnawing feeling to stop. We feel it too. However, as I look at your portfolios, and the assets you own, I start to feel better. There are investments which are losing value with markets but within these are good companies with strong balance sheets, and strong businesses. The very act of diversification means that even if a company in an investment fund fails, it is not catastrophic.
When reviewing portfolios we consider if an investment still serves the purpose it was originally intended. Even given current conditions, if we were starting from here, this would be the place to start. Clearly, we are all generally not starting from here. In the short term we see our investments have lost value. However, you still own these assets. They remain, in our opinion, quality assets. I don’t want to give them away cheaply.
If we take away the emotion (easier said than done, I know), long term return expectations are the highest they have been in many years. Assuming investment returns regress to long term averages, the expected annual return for Australian shares in in excess of 11% p.a*. Global shares are a little less than this. As always there are no guarantees these projections never travel in a straight line. However, if we are looking at the cold hard numbers, it is hard to justify selling these types of assets at this time. Indeed, it suggests adding to growth assets would be the logical outcome. In the current environment, this is a big ask. However, as the medical emergency wanes, markets will, at some point look at the lowest interest rates ever, the lowest asset prices in many years, an end to the recession and the long-term prospects of companies that have survived the recession.
We have every confidence that if you can weather current conditions, your portfolio will recover and prosper in the long run. We believe the investment assets you own are sufficiently diversified and well managed to come through these conditions in good shape.
We are hearing anecdotal evidence that super fund members without advisors are ‘cashing out’ and then phoning the call centre for affirmation they have done the right thing. They haven’t, but they won’t know it for some time. You have us. This is what we are here for. If in doubt, call us. We are with you through this in every sense.
(*assumes long term average for market dividends, growth in earnings and relative valuation – PE. I can take you through these assumptions in detail if needed).
Information current as at 17 March 2020.
This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date.