New article from Tatton Investment Management: Looking through the noise of the week

3 February 2020

The events of the past few weeks have left some investors wondering whether we are witnessing a rapid deterioration of the erstwhile ‘fair to potentially better than expected’ 2020 outlook. In light of the Chinese Corona virus threat to all kinds of human activity, equity markets are at levels that could be pricing-in more positive developments than is now realistic to expect. On top of this, central banks appear to once again be moving to a less generous stance in supporting markets with additional liquidity. Brexit has also re-appeared on the business radar with a reminder that planning uncertainty may have reduced but has not disappeared.

The downward movement of stock markets around the world since the Corona virus outbreak is a visible sign that investors suspect the restrictions that have been imposed to limit the spreading of the virus will dampen economic activity for a while.

The immense clampdown underway across China is unprecedented. In particular, it is disrupting supply chains, financial markets, and cash flow for businesses that were hoping for a change in fortune after a difficult 2019. Chinese smaller companies that are most vulnerable to bankruptcy may not survive unless they receive government help. The Chinese government is therefore expected to increase its economic stimulus package significantly beyond the levels it had initially deemed sufficient to overcome the 2019 growth slowdown.

Back to the virus, we would point concerned readers to our dedicated article in last week’s edition (Wuhan virus makes global markets sneeze) and reiterate that attempts to stem its spread may prove a bigger problem for markets and economies than the illness itself.

It is nevertheless worth pointing out that every year, seasonal winter flu around the world causes severe illness for between 3-5 million people. Of that number, between 290,000 and 650,000 ‑ predominantly those with previous health conditions – die as a consequence (Source WHO). It appears the Corona virus has a very similar impact across affected populations in China to the usual flu patterns, with the difference that it is new and therefore not covered in the available flu vaccinations. As we said last week, because of historical experience, humankind is prone to being overly fearful about fast-spreading viruses – even though it happens on an annual basis So far, scientists expect this virus to behave like other flu outbreaks which rise in December, peak in February and fade by April. Flu is always nasty, particularly for the already infirm, so we have a duty as a global society to do our best to prevent its spread.

Until proven differently, we have to assume that this viral flu will have similar effects on the global economy as previous ones, which was ‘some’ in the affected quarter but ‘very little’ over the course of the year. With the Chinese economic stimulus measures for 2020 now likely to become much more substantial than originally anticipated, this could provide significant demand stimulus for the global economy later in 2020, even though it would come at the price of more pain for the Chinese economy further down the line, when they will have to cope with the negative side effects such measures have inflicted on their economic structure in the past.

We will refrain from spending much time on Brexit day today, as there is ample coverage everywhere else, but also because the real Brexit day will be 31 December 2020 at the earliest.

More important for the UK this week was that the Bank of England (BoE) – against expectations, including our own – refrained from cutting interest rates by 0.25%. No change was a big decision for the Bank of England’s Monetary Policy Committee, so we comment on this in detail in a separate article. For the moment it has led to a strengthening of £-Sterling, which is good news for those going on winter holidays abroad, but not as good for UK businesses whose goods and services have become more expensive in export markets.

While the BoE decision seemed to confirm the view that central banks may be becoming less supportive, the same could not be said about the US central bank’s decision-making this week. Even though the US Federal Reserve (Fed) also kept rates on hold as expected, they did not – as widely feared – cut back on the monetary support measures they had put in place last September. This response to a tightness in transactional cash levels had been widely attributed as one of the driving factors behind the stock market rally late last year, and therefore its removal was expected to cause some form of market upset. As it happened, the Fed acted very responsibly again and only signposted a reduction of this support for later in the year.

It was notable that the rate setters both in the UK and the US saw the global economy improving and becoming less fragile.

The big decisions being made currently are not about today’s interest rates but about the nature of their goals and frameworks. Fundamental reviews are ongoing among the major central banks which could change the way they behave. Both the Fed and the ECB are aiming to deliver these around June. We think the central banks are likely to make changes which will be positive for economic growth, but which may also raise longer-term inflation expectations. Riskier assets like equities should do well in such an environment, especially in relation to bonds, which may fare less well.

In summary, the media storm over the spreading of the Corona virus made it an unnerving week for investors and this was certainly reflected in stock market activity. However, beyond the noise, we noted numerous improvements on previous concerns and headwinds which tell us, that once calm returns over this latest flu scare, the underlying economic and market picture is continuing on its improving path. The virus headwind may have stopped a surge in stock markets that had gone beyond reasonable valuation levels in some areas. This may be painful for some, but we see it as a healthy, cathartic market action which should lead to an improved foundation for the year ahead.

 

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