09 Mar 2020
The Australian market has declined 19.6% since it peaked on 20th February 2020 with a big 7.9% fall yesterday and we will see another significant drop today (down over 3%), as the US market’s falls continued. The US market has fared no better falling 18.9% since the highs over the same period, although we have had some protection from the lower AUD.
The Coronavirus has certainly unsettled investors as it continues to spread. While it seems to be highly contagious but not that severe to otherwise healthy people, the reaction to the virus and in particular cancellation of events, closure of workplaces and isolation of individuals is going to have an unprecedented and unknown economic impact. However, this impact is not a structural economic problem and it will pass. What we cannot know is how people will behave, as the toilet paper hording shows.
The fact that markets had been at highs when the drama started is why the falls have been so dramatic. A company’s value does not change that much if sales drop for a year. As long as the business does not have high operating leverage (high fixed costs relative to variable costs, so cashflow will really be hit) or too much debt, temporary interruptions no matter how severe will not have a significant impact on long term value.
No one can determine the short-term impact on the economy and company earnings. However, when investors are uncertain, they do not tend to buy, so any panicked selling has an exaggerated impact on the share price.
Now the market has been hit with another significant surprise. Get ready for cheaper petrol as Russia has not made a deal with OPEC to cut production. OPEC would be an illegal cartel in Australia, Europe or the US and it shows you how much the cartel pushes up prices when you see a fall of 24% when Russia suggests they will not cut production.
Russia have not turned a corner and decided that they think the cartel is an abuse of economic power. They are playing games. They do not benefit from a lower oil price. They just want to get the Saudis to do most of the cutting. Once again, not a long-term change.
However, at the moment it is shoot first and ask questions later. The banks are having a horror run as low interest rates are no good for bank margins, especially when they passed on the full 0.25% interest cut immediately (the government must have been holding the CEO’s families hostage) and bad debts are expected to rise as there will be weaker businesses, that will struggle to get through tougher times.
These sort of markets make everyone uncomfortable. We are human beings and we are more driven by emotion than reason.
We acknowledge the high degree of near term uncertainty and in a world awash with debt, shocks to the system can expose weaknesses. However, as long as you stick to quality companies and are not over exposed leading into the falls, these situations most often provide buying opportunities for the medium to long term investor. This is because at some stage the world will return to normality and quality companies will be making big, sustainable profits again.
If you have any questions or require any further information, please contact our office on (03) 9629 1100.