Investment Update – 25 March 2020

The scale of the impact of the near shutdown of the world economy is becoming clearer by the day.  The immediate hit to economic activity through disruption to supply chains, business closure and social distancing measures is an unfortunately necessary consequence of the virus if we are to protect lives and prevent its rapid spread, overwhelming health facilities.  Governments are, therefore, grappling with two problems: one, to slow the spread of the disease sufficiently such that health services are not inundated, and two, to ensure, through their policy action, that the impact of the resulting immediate economic disruption does not translate into more long-lasting economic harm.  Examples of this would be widespread unemployment, the collapse of otherwise viable businesses or dislocation of the financial system.  If these can be protected, the economy will be in a good position to resume once the necessary shut-down is lifted.  In that regard, the measures announced by European, UK and US governments, among others, are the correct response.  Central Banks are ensuring that (i) liquidity is available to the financial system, (ii) credit flows can be maintained, and (iii) the cost of finance is kept as low as possible, while fiscal policy is being used to support business solvency, employment and incomes directly.  While the scale of the current disruption remains unclear, it is impossible to tell whether the measures announced so far will in themselves prove sufficient, but already they are of a magnitude unprecedented for a peacetime economy.  If more is needed, they are most likely to be followed by further action.  The textbook response to such a crisis, as was said by the Chancellor of the Exchequer, Rishi Sunak, last week, is to do “whatever it takes”.

 

The immediate hit to global GDP is likely to be at least as great as in the early stages of the global financial crisis (“GFC”) in 2008 / 2009, but currently there is a noticeable lack of global co-ordination in the response.  While many governments have already announced unprecedented levels of support for their own economy, there are some developing countries less able to follow without international co-ordinated action through the IMF, G20 or other bodies.  Multilateral action can often be more effective than unilateral action, even where individual governments are already doing the right things.  The Organisation for Economic Co-operation and Development (“OECD”) began to tackle this issue at the start of this week and appears determined to provide a platform to assist governments to take such co-ordinated action.

 

It is clear that bigger budget deficits and higher debt would weigh on heavily indebted countries for years ahead.  While this is of course true, it should not be overstated.  Though the fiscal and monetary action now will result in larger governmental debt levels, this is something that has become more accepted following the GFC since when debt levels have doubled from 40% of debt to GDP without difficulties in treasury markets.  The servicing of this debt has been made more palatable due to significantly lower interest rates, which have dropped from c.5% a decade ago.  Over the longer term, however, one of the likely fiscal consequences in this country is higher taxation, which is slightly different to after the GFC when much of the heavy lifting of austerity was done by way of reduced public spending – this time, the balance is likely to shift due to the need to improve the healthcare infrastructure and the pressures on Government to bring about more equality in society.

 

What we do know, from studies of previous shocks to the world economy (epidemics, natural disasters and the like) is, while the initial impact on the affected economies can be severe, such recessions tend to be relatively short; much of the lost activity can be made up following the return to greater normality once the shock has passed.  Such recessions are typically more V-shaped than was the case following the GFC, in which the ensuing recession was prolonged by the inherent faults within the financial system at the time.  In the current crisis, while the incidence of the virus is widespread, and the initial disruption severe, there is still an expectation among health professionals that the peak infection rate should be reached by the summer and then start to decline.  At the same time, as more people are exposed to the disease, the level of immunity among the population should increase, while, given time, the peak capacity among our health services can be raised somewhat to cope with those with severe complications.  As a result, it is still likely that the degree of disruption will diminish before the end of this year, allowing economic recovery to take place as we move through 2021.

 

In the meantime, and at an individual level, (i) good financial planning (the correct asset allocation to match the individual family circumstances), (ii) investments in company shares in preferable sectors such as healthcare, IT / software / technology and consumer non-durables, and (iii) appropriate cash reserves and sovereign bond allocations (rather than corporate debt of which we have none in our portfolios) should stand you in good stead to be financially well placed for this extraordinary exogenous shock to the economic system that we are all facing.  We are working on some material showing the underlying holdings of the company share funds in which you are invested; these are currently showing a resilience to the market declines that should provide further reassurance to you.  

 

In a speech on Monday 23 March 2020, the Secretary-General of the OECD, Angel Gurria, noted that cool heads, individual and collective discipline, a heightened sense of solidarity and a shared sense of purpose will allow us to overcome these unexpected and challenging circumstances.  These are sentiments with which we agree at London Wall Partners; we will continue applying our collective minds in a deeply thoughtful manner to be well positioned to advise you appropriately.  There are likely to be more fear-inducing headlines and market volatility on the way, and those cool heads will be required.