McCulloch & Partners Quarterly Insights: Coronavirus Strikes the Market

Coronavirus Strikes the Market

The coronavirus spread rapidly across Europe and North America during the final 6 weeks of the quarter, bringing the global economy to a screeching halt. Financial markets responded in kind, pictured in Figure 1 below. In the equity markets, US markets went from all time highs in mid-February to a bear market in record time. The S&P 500 ended March down 20% for the year, with the TSX down 21%. In the credit markets, spreads widened rapidly in both the investment grade and high yield spaces, figure 2, putting additional stress on companies’ balance sheets at a time when top line revenue for many companies is coming under considerable pressure.


There seems to be no way to avoid a massive hit to the global economy during Q2, as social distancing and prevention measures come at the expense of the economy. The bigger question that remains unanswered is the necessary duration of these measures, and how soon before economic activity will be allowed to find its footing again. Increasing the testing capabilities of countries around the world, coupled with evidence that social distancing measures have achieved success in Europe and North America in stemming the infection growth as it appears to have done in Asia. These look to be necessary conditions for society to begin to feel that there is a path forward to ultimately beating this outbreak.

To that end, there are early signs that the quarantine measures in various centers globally are looking somewhat positive. Also, it is quite amazing to read stories and articles daily about medical professionals and companies around the globe devoting their full attention to aiding in the fight against this virus. Abbot Labs has developed and is seeking to mass produce a 5-minute test for detecting if someone is infected with the coronavirus, read story here. Dyson, a maker of vacuums, developed and is producing ventilators over a 10-day period, read story here. Chalk one up for private enterprise and human ingenuity and will.

Central banks globally were quick to act, with a massive round of rate cuts coming across the globe. Central banks also either continued or began to purchase bonds in the secondary market, also known as quantitative easing. We have also seen governments in the US and Canada are delivering their own form of stimulus, including increasing unemployment benefits, increasing lending to small businesses, and delaying income tax filing deadlines. Governments and central banks have promised to deliver all of this, and stand ready to deliver more forms of stimulus as needed, in the hope that they can help stem the rapid onset of financial distress that has been heaped on businesses and their employees, as well as in the financial markets. Initial unemployment claims in the United States over the last two weeks came in at historic levels, approaching 10 million. These truly eye-popping numbers as seen in Figure 3 underscore the need for governments to deliver targeted and effective fiscal policies to help their populace, and they need to deliver it quickly.

Figure 1: Snapshot of global equity markets, Canada and US Aggregate Bond Indices, and the USD/CAD exchange rate

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Figure 2: Red line is the US High Yield spread, Blue line is the Investment Grade Credit spread, both spreads widened rapidly during the last 6 weeks of the quarter

Figure 3: Unprecedented levels of Initial Claims, blue line, points to a rapid increase in the unemployment rate, red line.

To complement the shock to the system caused by the coronavirus outbreak, the OPEC+ group, also known as Saudi Arabia and Russia, decided to end their long standing policy of production cuts to reduce any over supply in the global energy markets and boost the price of crude oil. This unexpected falling out between two of the largest oil producers in the world sent oil prices down over 60% in the first quarter of the 2020. It was a perfect storm for energy prices, with an expected increase in potential supply coupled with a severe demand curtailment as the global economy ground to a halt. There may be some relief for the beleaguered energy sector globally, as discussions between the United States, Saudi Arabia, and Russia have the potential to bring the supply side of the equation to a constructive end.


It feels like years have passed since we were starting the year with the escalating of tensions between Iran and the United States, yet it was only 3 months ago. That is all to say that the first quarter of 2020 will go down in the history books and will be remembered by everyone for the sheer weight of the disruption that hit our planet on a multitude of fronts. As allocators of capital, we must be concerned not only with what is transpiring but also on what we believe probabilities of future paths forward to be.


To that end, the duration of the need for quarantine measures to combat the outbreak and spread of this virus becomes critical. Asian countries have begun to emerge on the other side after taking decisive action. We believe it is vital to see peaking in the growth of new cases before we can truly begin to recover, and likewise for markets to begin to realistically price in economic recovery.


This means that the ability to quickly and effectively test large swaths of the population is of the upmost importance, as this will enable us to isolate and treat those who are sick effectively, while limiting the potential for them to spread the virus to others. Also, widespread testing will allow us to determine who has developed immunity through contracting and beating the virus, allowing us to methodically get our people and economy moving again. Past that, treatment options to reduce the effects on the infected and an eventual vaccine will allow us to emerge victorious over this pandemic. The potential in these areas being proposed and developed in such a short time is a true testament to how far healthcare and technology have progressed in enabling the best and brightest medical professionals and researchers to seek out the answers we need as a society.


The biggest risk to global financial markets outside of the actual spread of the virus at this stage is the fact that during this period of low interest rates, corporations and governments have continued to borrow at increasing levels. The longer that the global economy needs to stand still to combat this virus, the higher the risk of this pandemic causing a cascading effect of credit stress on the financial markets and system. As such we remain very vigilant of overall developments in the credit markets, as well as prioritizing balance sheet strength in our portfolio companies, as well as remaining very selective in our allocations within the fixed income space of portfolios.


Within equities, we continue to favour areas that we believe will be leaders coming out of this turbulent period. Some of our core themes, such as global infrastructure, cloud systems, and cybersecurity, will continue to be in demand and will continue their growth. Other areas, such as mobile payments, medical devices, robotics, and AI, could see their growth profile sped up and their rate of adoption increased coming out of this event. The work being done by companies in medical devices, for example, are of huge importance to produce enough testing capabilities for society. Within robotics, manufacturers that were not actively looking at how they can reduce the human component of their processes will very likely prioritize this coming out of this crisis. We also believe that technology will play a huge role globally for life post coronavirus with regards to future health care and prevention. An example of this could be a scan before entering an airport or public venue that takes your body temperature.


By taking a focused approach to seeking out potential areas that will be leaders coming out of this, allows us to prioritize where we want to position capital with the public equity component of our portfolios. As always, within equities we continue to value companies with strong balance sheets and cash flows.


With interest rates continuing to hover at extreme lows in the wake of this crisis, we continue to favour alternative asset classes and strategies within portfolios. Alternatives continue to serve an important role as risk mitigators, as well as alternative sources of yield.


These are very fluid times for everyone, and we are extremely cognizant of that. As more information becomes available ideas and estimates as to where we are in this crisis will continue to evolve. We wish to remind all our clients that we are here at any time to answer any questions and to update you on how new information has shaped our viewpoints, and we encourage you to reach out however frequently you wish to discuss events. We have found this site, run by Our World in Data, to be a good source for data globally on the coronavirus. We do not know with certainty where in the cycle of this crisis we are, but we know that we will emerge out the other side. Society will however adapt and change, such as the level of security screening at airports and public venues after 9/11, or the change to the global banking system coming out of the Great Financial Crisis. We anticipate that certain areas of economic activity will be slower to come back if they do at all, but other areas will continue to grow and succeed, and those are ultimately the areas we endeavour to allocate capital. However, first and foremost, we need to get widespread testing capabilities globally to begin to allow people to get back to work, and the global economy to restart.



All data and/or charts are sourced to Thompson Reuters Eikon unless otherwise noted.
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