New article from Tatton Investment Management: Coronavirus - hitting too close to home

2 March 2020

What a difference a week makes. For most of February, we had been discussing on these pages why equity markets had remained sanguine about the virus scare and even reached new all-time highs. At the end of this week, there is very clearly no need for such discussions any longer - equity markets around the world have turned and rapidly entered correction territory.

 The rapid spreading of confirmed infection cases throughout the western world has ended the (now clearly misguided) belief that the implications of COVID-19 would be confined to faraway China. Even Donald Trump's TV broadcast proclamation on Wednesday night that "Because of all we've done, the risk to the American people remains very low" was unable to persuade the wider public that the virus outbreak would not touch them personally one way or the other.

To paraphrase the famous economist Paul Samuelson: when events change you change your mind. When the virus initially took hold in China, rational investment considerations from the professional investment community dominated were based on past experience that similar pandemics do not leave lasting damage and have not historically caused lasting recessionary periods. On the contrary, history tells us that monetary and fiscal stimulus countermeasures have usually led to a v-shaped recovery, once the warmer and dryer weather of spring brings the annual flu season to its natural end. However, once there was an increasing count of confirmed cases in South Korea, Iran and Italy, investor sentiment flipped, as less rationally inclined investors headed for the exit, creating a downdraft momentum that at the time of writing is still in full swing.

The severity and suddenness of the sell-off has been widely covered (and embellished) by the media and as readers will have noticed also resulted in us at Tatton issuing two adhoc updates on Wednesday and this Friday morning. Those who read last week's edition will also remember that we noted then that stock markets were vulnerable to sudden, crash-like corrections because we had entered this difficult period with already quite extended stock market valuations following a very prolonged bull market and economic cycle.

That said, it is also worth noting that not much has changed factually since last week. China, the epicentre of the virus outbreak is reporting a steady decline in new infections and the country is returning to work. Both improvements reflected in positivity in the Chinese stock markets - in stark contrast to everywhere else.

As the virus has turned from an abstract economic hindrance to a personal and daily life changing threat, its impact on collective investor behaviour (and therefore market activity) has become far harder to gauge and forecast. During violent market movements as we're experiencing at the moment, the least potential damage comes from as little action as possible, given the propensity of wild swings between under-reaction to over-reaction.

As the virus has turned from an abstract economic hindrance to a personal and daily life changing threat, its impact on collective investor behaviour (and therefore market activity) has become far harder to gauge and forecast. During violent market movements as we're experiencing at the moment, the least potential damage comes from as little action as possible, given the propensity of wild swings between under-reaction to over-reaction.

The offsetting elements we discussed over the last weeks remain in place, as the positives include a global economy on a fairly durable footing, central banks that remain supportive to counter credit market deterioration and governments at the ready to provide fiscal support should it be required. However, as we also discussed, the feared negative economic ramifications are mostly related to the containment countermeasures of restrictions of movement, rather than the actual illnesses and fatalities. Under these circumstances we will need to adopt a 'watch and wait' stance for the near future to ascertain whether our previous fundamental assessments need to change.

If the spread of the pandemic is indeed already on the decline - as the figures from China indicate - and/or the Western world can deal with infections more effectively because of the one month warning our health systems received, then there is the possibility that this pandemic will follow the same relatively benign path for the economy as previous ones. On the other hand, much will depend on how much reduction in public and social activity will be necessary to contain the further spreading enough to defuse and restrain the public health impact of the virus. Should it become necessary to escalate such measures to levels China imposed over weeks then this could constitute a significant enough inactivity shock to the global economy to become the catalyst that ends this longest cycle in recent history - even despite all of the potential countermeasures aforementioned.

At the moment, we cannot know exactly what shape and direction the virus containment and market actions will take. But Team Tatton has plenty of experience of dealing with bouts of market volatility, and history has taught us that the best course of action usually is to 'keep calm and carry on'.

We will therefore continue to do exactly what we have done over the past 30-40 years of our capital market involvement. That is, to assess the developing dynamics in markets, evaluating the economic issues as well as political and societal concerns, all with the aim of steering investors' investment portfolios through the stormy waters towards the longer term enhanced returns over bank savings they expect from investing in capital markets.

For the immediate future, we will continue to look for good reasons to buy back into the much-cheapened stock markets, while remaining mindful that the more prudent approach could be to sit things out, or to even reduce risk levels if evidence emerges that COVID-19 will leave a bigger dent in the global economy than previous pandemics. As always, we will be observing developments very closely and act when necessary or opportune. But even if no action is deemed the best course of action, we will continue to report back to you on a weekly basis or even intra weekly to keep you abreast of the latest insights.

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