Investment Comment March 2020
4th March 2020
The spread of the Covid-19 virus outside of China derailed equity markets in February. At the time of writing (5 March), there have been 95,700 cases and over 3,280 deaths from the virus. China remains the most heavily affected country, with around 80% of cases located in the country. However, Korea, Japan, Iran and Italy have also been particularly affected. The UK situation has also become more concerning, with the government launching a coronavirus action plan amid rising reported cases of the virus. Economically, we have entered a period of relative unknown; some lessons from the SARS episode of 2003 can still be extrapolated but the economic environment is much changed. With less clarity in markets, investors were again quick to retreat to safe haven assets as shown by decline in the yield of developed market government bonds.
The MSCI Emerging Markets index was down only -2.24% in February, outperforming developed market indices globally. Unlike the rest of the world, infection rates in China stabilised in February. This was attributable to the implementation of a lockdown of Hubei Province (the epicentre of the outbreak), inhabited by 50 million people, and the temporary shutdown of many industries. The improving situation was received well by Chinese equity markets which moved marginally upwards over the month. The containment measures did however have the effect of halting the economy, with the February Services PMI plunging to a record low of 26.5, from an expansionary reading of 51.8 a month earlier. Coal consumption in China, a key indicator of the country’s activity, also languished around 30% below normal levels at the end of February. The outbreak has also underlined the importance of China to world commodity prices, in particular oil, which fell 13% in February, and industrial metals, which have sharply declined since late February. More recently, there have been signs of a return to normality in China; large multinationals such as, Starbucks and Apple, have announced the re-opening of stores and factories in the country and according to the PMI survey, 90 per cent of medium and large-sized manufacturers are expected to resume production in March. The People’s Bank of China $16 billion coronavirus pledge and cut in the loan prime rate should help stem the spread further in the coming months and aid the disproportionately virus-hit sectors like hospitality, infrastructure and raw materials.
The US equity market sell off was more pronounced with the MSCI USA falling -5.27% in February. This was certainly not a reflection of January economic data which remained strong with retail sales up +4.4% year on year and the economy adding 225,000 new jobs. Composite PMI data for February did however dip below 50 for the first time in six years. This was predominantly attributable to declining service sector activity caused by a notable fall in new business from abroad amid growing coronavirus fears. Since the release of preliminary PMI data on February 21, US equity markets, in addition to selling off, have experienced a sharp rise in volatility. Indeed, the VIX index, which reflects the amount of volatility traders expect for the S&P 500 during the following 30 days, has risen over 200% since mid-February. Although the emotional response may be to sell in such situations, on average, the S&P 500 has generated a return of over 25% in the 12 months following the VIX breaching 32.9. The data was however concerning enough for the Federal Reserve to cut the policy rate, this time by 0.5% to 1.0% to 1.25%. Market commentators have since suggested that the Fed is likely to continue on this path with further cuts expected this month and next. In addition, with the odds shortening for the centre-leaning, Joe Biden, to become the Democrat candidate, the political risk for US equities seems to have abated.
Despite the spread of the virus being very minor in the UK in February, the stockmarket fell sharply during the month, with the MSCI United Kingdom returning -9.12%. However, the theme in the latest round of economic data continued to be that of an ongoing recovery. A post-election boost was evident in economic activity with GDP rising 0.6% from -0.3% in November to +0.3% in December. Inflation was also less subdued, at 1.8% In January, the highest reading in six months. Meanwhile the residential property market appears to have been reinvigorated by the December election result with the Nationwide House Price Index rising 2.3% in February, to levels again not seen in six months. PMI data for February was even more impressive with the Manufacturing PMI reading 51.7, the largest increase in factory activity since April 2019. At 53.1, the Services PMI remained strong. If the decline in UK airline activity and the collapse of Flybe is any indication though, March figures will likely be less positive. However, the government is poised to loosen fiscal policy by around 0.5% of GDP in the upcoming budget which should help in offsetting the impact of the virus.
Returns in Europe were -5.42% in February. GDP growth for Q4 2019 was revised down to 0.9% from 1%. Survey data was however more promising, with the Manufacturing PMI nudging closer to expansion territory, at 49.2, and the Services PMI holding steady at 52.6. Despite the improvement in manufacturing data, the survey showed export orders continuing to decline and average lead times for the delivery of inputs lengthening for the first time in a year, mainly caused by coronavirus-related factory shutdowns in China. Moreover, Italy, the Eurozone’s third largest economy, is now expected to see a £6.4 billion fall in tourism activity as a result of the outbreak. This coupled with the country’s closure of schools and universities has led many commentators to predict a technical recession in the country in the short term. Furthermore, the OECD has suggested that Italy may not be alone and that other eurozone economies could also contract this year. The bloc’s already fragile growth state and reliance on global supply chains have been cited as the main reasons for this. That said, if Italy’s €3.6 billion efforts to contain the virus are effective in the short term and the crisis gives Germany an excuse to breach its constitutional spending limits, the growth picture for Europe may be less bleak after the virus has passed.
Japan also suffered during the month, with equities returning -6.24%. Economic data released in February revealed an ever-worsening situation in the country. Despite forecasts factoring in Typhoon Hagibis and the consumption tax hike, Q4 growth still sharply surprised to the downside, falling an annualised 6.3% during the quarter. Survey data also showed contracting activity in both the services and manufacturing sector. Although revised up from preliminary estimates, the Services PMI was the lowest since April 2014, at 46.8. Unemployment however remains robust, at 2.4%, and retail sales growth showed some sign of stabilising, down only -0.4% in January. All of the stockmarket fall has been since the de facto order from central government to close schools until April 8, affecting 13 million pupils. This is likely to drag on the economy further in March and with policy options dwindling, analysts now view a technical recession as likely in Japan.
There is a clear consensus between international banks that global growth will now be lower this year. The magnitude of the banks’ revisions has varied greatly though. In novel times like this, historical data may seem irrelevant, but it must be noted that historically, market volatility has been a long-term investor’s friend. That said, we remain cognisant that some economies may be less well equipped to deal with this outbreak than others, and that these stock markets may suffer for longer than others. However, evidence illustrates that trying to time entry and exit from such markets has proven ineffectual, so we continue to encourage staying invested during this time. Holding a diversified portfolio, including fixed interest assets, which have rallied of late, should help provide some downward protection as global economies attempt to navigate this difficult human and economic time.
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice as at the date above, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future.