Posted 10.03.2020 in Industry Updates
While these events aren’t unrelated, the oil price fall has more to do with the competing interests of Russia and OPEC than it does genuine fears for the economy. Lower energy prices should ultimately help economic growth but in the short-term oil price instability adds to uncertainty.
While yesterday was a shocker with a 7.73% fall on the ASX 200 index, we have seen the market responding to announcements in the US, rising 1.38% mid-session. In our last communication we suggested that in an unexpected event like this, the markets are searching for signals for price discovery. In the absence of hard data, markets trade with significant volatility. This is exactly what we are experiencing at present.
This is a concerning time for all investors and without coordinated Government intervention it is quite possible that we could see Australia fall into recession for the first time in almost three decades. That said, we do not have any reason to think that this is a repeat of the GFC – it is not 2008.
At this point the most likely scenario is for the impact to be sharp and deep, yet when a coordinated policy response is delivered, we will see confidence return. Seeing Italy’s borders close this morning tells us that authorities are willing to take aggressive action to contain the spread of the virus. Undoubtedly these kinds of actions will cause an economic shock in the short term and this is what financial markets are trying to price in.
For context I have included the graph below which shows the intra-year market falls against the calendar year price returns. The market fall refers to the largest drop from peak to trough before a subsequent rally.
The data shows that in the past 35 years, the average intra-year drop has been -12%, with a significant, (-10% or more drop), in 25 of the years, while the market posted price gains in 26 of the 35 years. While this seems counterintuitive, it’s exactly what happens in markets. The average price gain over the period was 8% per annum, plus dividends.
While this data does not explain the Covid-19 market turmoil it does reaffirm that market volatility is very, very common, and it is the price we pay for a higher expected return on risk assets.
We certainly acknowledge the discomfort people may be feeling, and that any attempt at soothing comments will likely be inadequate. Yet the facts remain – the global economy was strong going into this event, and with the right policy responses we expect economic growth to resume once the Covid-19 risks subside.
As we at Capital Partners have said in many of these events before, this is a time for cool heads and a long-term perspective.