WHERE MIGHT CORONAVIRUS TAKE MARKETS?
As I write this we are in the middle of a market shake-out. Newspaper headlines are screaming, but this is a healthy action for markets and market participants. In the absence of a negative catalyst, it is the nature of equity markets to rise. Citigroup’s Chuck Prince famously said to the Wall Street Journal in 2007 that ‘if the music’s playing, you’ve got to get up and dance’. Even when valuations become unsustainably extended, markets need a reason to start the process of correction. Today we have that in the fears over coronavirus. It was unexpected, the prognosis is very uncertain, and it has the potential to dent corporate earnings and therefore ultimately dividends. This last point is crucial, because the value to investors in quoted equities is the income stream which they throw off. If investors judge that that will be reduced, they will lower their ‘fair value’ for the company’s shares. For example, the oil shock in the 1970s transferred wealth to the oil producers and lowered global growth, earnings and dividends. On other occasions, the catalyst may be more technical, perhaps a shortage of liquidity in the markets or the hedge fund fraternity deciding to short the market. There may be some fundamental reason behind their thinking but the point is that the cause is largely in the financial rather than the real world. The sell-offs over the last ten years (eg. 2011, 2016, and 2018) have not been followed by major recessions or hits to corporate earnings. And yes, there is another actor, of course. The Federal Reserve (I’ll use them as a proxy for central banks globally) has over the last 25 years reacted to threats of market mayhem by printing money. We used to call it the Greenspan put, and more recently Quantitative Easing, but there is no reason to believe they won’t do it again this time round if needed. So which is coronavirus? Is it purely a catalyst for a largely technical sell-off or is it already so serious that it will impact corporate earnings? Let me start by saying that I don’t believe that 670 years later the equivalent of the Black Death has once again arrived on our shores. Given modern medicine, I’m sceptical that it’s even the equivalent of Spanish flu in 1919. Unless you are over 60 – confession, I am on the cusp - mortality rates are low. And if you are over 70 you are likely to be largely retired so not contributing to global productivity. However, the way the authorities have reacted, by trying – King Canute* comes to my mind – to prevent an epidemic, has made an impact on both consumption and manufacturing inevitable. That in turn will hurt any global business which rely on them, whether luxury goods, airlines, travel or producers using components made in China. It seems to me that a reduction in corporate earnings is inevitable, but equally so is the likelihood that governments and central banks will react by easing monetary and fiscal policy further. It is only if those actions have no effect in stimulating growth - or regulators do something additional, such as the threat that the UK’s Pension Regulator’s might shorten DB deficit recovery periods - that markets really will take alarm. It is too early to predict just yet but the odds are shortening. *King Canute or Cnut’s story is often mis-told and the original version in Historia Anglorum was as follows: when he was at the height of his ascendancy, he ordered his chair to be placed on the sea-shore as the tide was coming in. Then he said to the rising tide, “You are subject to me, as the land on which I am sitting is mine, and no one has resisted my overlordship with impunity. I command you, therefore, not to rise on to my land, nor to presume to wet the clothing or limbs of your master.” But the sea came up as usual, and disrespectfully drenched the king’s feet and shins. So jumping back, the king cried, “Let all the world know that the power of kings is empty and worthless, and there is no king worthy of the name save Him by whose will heaven, earth and sea obey eternal laws.