MARKET UPDATE:
Q&A with Infocus Chief Investment Officer, Jeff Mitchell

1. Jeff, with regard to COVID-19, the campaign to ‘flatten the curve’ here in Australia seems to be running to plan for now and particularly given we’ve hurdled the Easter break seemingly well, what do you think that means in terms of the outlook for our domestic market and the path forward?

Until the start of the US reporting season 2 nights ago, share markets including ours appeared to be driven primarily by Covid-19 infection rate data. i.e. as the curve has flattened it tended to buoy markets.

While it is still early days in terms of assessing the economic impact the earnings reports particularly for financial stocks in the US is causing the market to consider the economic impact of Covid-19 and as much as socially it is feeling like we have turned a bit of a corner, the economic reality of rising unemployment, falling consumption, lower trade volumes and ongoing economic dislocation caused by social distancing will act as a drag on markets.

The longer the quarantining measures remain in place the longer the economic dislocation and the longer the road back. We note the IMF report released yesterday paints a dire picture for 2020 with growth falling 6.7%, but forecast a rise of 6.1% in 2021. If this were to happen, then in my view it will be a great result.

It is still too early to really know.

2. Internationally, things don’t seem to be going quite as well with the impacts across Europe, the difficulties being faced within the US, a possible recurrence emerging across Asia, and limited data out of the developing nations. What is your view in terms of how this might all play out in the international markets?

Covid-19 is a global pandemic and while countries have tried a range of strategies to deal with it, we all appear to be ending up roughly in the same place economically. I would expect that in the developed world, markets will in general terms, have a similar experience going forward. The exception would be if one country or region has a very different experience with reinfection should it occur.

So, the path forward, the longer the quarantining measures remain in place the longer the economic dislocation and the longer the road back. We note the IMF report released yesterday identifies a ‘V’ shaped recovery through 2020 and 2021, and if this is the economic path then markets will likely run ahead of it. In our view this is likely a ‘best case’ scenario - others would be the ‘U’ or ‘W’ shaped recovery and the more concerning ‘L’ shaped outcome. Given the amount of monetary and fiscal stimulus governments and central banks have thrown at Covid already, it will clearly act to soften the negative economic impact and while that is what is required, it probably points to the recovery being more a ‘U’ or ‘W’ shape rather than a ‘V’. Again, it is still too early to really know.

3. Do you think the prospect of a global depression has softened to a more-likely global recession now, and is Australia in the same position?

A global recession is all but called - a depression is less likely based on the amount of stimulus applied already and the preparedness of governments and central banks to ‘do whatever it takes’ (a repurposed phrase from the GFC). That said nothing is a certainty.

Australia is faring better than most financially as our Covid response cruelly snatched away Josh Frydenberg’s ‘so close you can taste it ‘budget surplus. As a country, along with about 130 others that name China as their largest trading partner, Australia as a whole may be advantaged as China continues to consume our mineral resource exports. However, circa 60% of our economic growth is domestic consumption, of which services comprise a significant proportion. It is this aspect that could see tough conditions domestically. So clearly a recession is on the cards- as for how deep and how long, it is still too early to tell.

4. You have made a number of changes to the investments you and your team manage so far this calendar year. Can you give us a brief overview of your activity and the thinking behind that?

The whole Covid-19 story began for global equity markets on Saturday 22 February. This was the day when it was announced to the world that coronavirus had broken out in northern Italy. Global markets quickly assimilated this news and developed world markets corrected sharply on Monday 24 and Tuesday 25th.

This event is a scenario we had prepared for and given we were overweight to shares in our managed account portfolios at this time we reduced the exposures to shares both in Australia and Globally.

3rd and 4th of March – Covid-19 quickly spread to South Korea and Iran. Global equity markets saw increasing nervousness and selling. The RBA in Australia cut interest rates and the Federal Reserve (Fed) in the US followed suite at an emergency meeting highlighting that Covid-19 was heading for pandemic status.

These events saw us sell down more of our share positions and go to an underweight exposure as we saw the risk to capital escalating.

10 March - Covid cases increase and oil prices collapse amid a dispute between Saudi Arabia and Russia over production cuts as demand for oil slows.

This we saw as a further decline in conditions and reduced shares and other growth assets further underweight.

12th March - WHO declares Covid-19 a global pandemic and Australian Government announces first stimulus package as recession fears rise. Market experiencing even higher volatility.

We considered that the situation had deteriorated further and an additional reduction to shares and growth assets was prudent. At the completion of this trade we are approximately 1/3 underweight to our ‘neutral’ exposure to share and growth assets.

19 March - globally governments really stepping up stimulus(rescue) packages to prevent economies melting down as social isolation measures to address Covid-19 effectively close economies.

We considered that we were underweight enough even though market volatility was at extreme levels both up and down days. We evaluated the stimulus packages and repositioned the portfolios toward resources and away from banks. And as bond markets began experiencing very tight liquidity conditions, we increased the cash position.

25 March - US Fed announces they are prepared to purchase as much debt, including investment grade corporate bonds, as required to stabilise the nervous markets.

We responded again and reduced the portfolios positions in listed property and Australian small caps where we perceive that debt levels are more of an issue and increased our positions in higher quality global equities which we assessed as more able to weather the storm and likely to recover more quickly.

From this point the market rallied circa 20% from the low of 23 March.

15 April – with infections rate curves flattening and a reduction in market volatility appearing to take hold, we traded to increase our global shares exposure moderately as we are of the view that our underweight position in growth assets could now be reduced.

Bear in mind that these portfolios typically would be traded once or twice a quarter.

5. What’s your view on ‘buying the dip’?

In normal environments buying the dip has its merits and indeed it has been a very popular and successful strategy previously. Typically, you can see a dip looming in the road ahead, sometimes there is a sign that says ‘Dip’, you pass through it and you see it in the rear vision mirror and you are heading up the next hill. These are the dips that occur more frequently and support the buy the dips approach.

This dip is of a different type, it is a bit like being on a new roller coaster in the dark. You understand there will be peaks and dips you just don’t know when and how steep or long, but once you are in the car you are in for the ride.

On the Covid-19 roller coaster we have already has a fairly good dip of circa 35% in 3 weeks, but there has been a subsequent rally and a not too bad one at that, but are we about to dip again or will the recovery remain intact? It is pretty hard to see us getting back to where we were in mid-February (new highs on the ASX) any time soon but there is the prospect we may have seen the biggest dip already, but we are fairly certain there will be others to come before this ride is over.

6. If I wanted to make a change to my investment strategy (e.g. to get an actively managed account) and/or ‘crystallise my losses’ for a possible tax advantage, would this be an appropriate time to do so?

The first part of your portfolio construction to look at is your current asset allocation i.e. your blend between growth and defensive assets. Is it right? i.e. does it align to your agreed risk profile?

If yes, then the option is to do nothing at this point.

If no, then speak with your adviser.

The second consideration is: Are my respective investments right for what I am seeking to achieve? Again, speak to your advisers, they will know.

The third consideration is that market movements could well have changed your portfolio’s position in relation to unrealised gains and losses. After a market correction has occurred this is a good time to re-evaluate the structure of your investment portfolio as you may well have the opportunity to reposition it to a better position without creating a tax consequence. Again, speak to your adviser, they will be able to help you with that.

Remember you don’t have to wait until you are presented with a situation like this. Revisiting your portfolio construction on a regular basis with your adviser is a prudent thing to do. It is just at times like these you have the opportunity to maybe do it more tax effectively than in more normal market conditions.

7. Is accessing superannuation to bolster living expenses a good idea at the moment?

It is not a good idea if you are not retired. That said, if your situation requires you to do it to survive then it is the last option you should consider. If you are confronted with a situation where you are contemplating emergency access to your super please speak with your adviser as they may be able to help you to access other government financial relief packages. All these options should be exhausted before you go to your super fund.

8. What if I am planning to retire soon, should I?

On the basis there are no other contingent factors in this decision, and you have a job that you can stay employed in, then it may be prudent to hold off retiring a bit as it is still too early to really forecast how all this is going to play out in financial markets and the economy. Remember, if markets fall significantly again this could further impact your super balance and in turn your retirement funding resources. Maybe consider going to part time or semi-retirement as an interim step until the future environment becomes a bit more certain. Everybody’s situation is different but at times like these it pays to consider all the options available to you. Covid-19 is a left field event - what made sense and seemed logical before it really kicked off in February may not be that way now, so time to revisit all major financial decisions in the new context before deciding what to do about it.

9. What are some of the considerations we should be mindful of in terms of the investment markets as we look toward a possible recovery?

Investment markets are long renowned for looking through gloom when it appears darkest and identifying the green shoots of recovery when they are least apparent. This will happen again but it will not happen without the odd false start. Remember markets can experience substantive rallies in bear markets. Even in Covid-19 the first decline was about 35% in 3 weeks and we have rallied back about 20% from the March 23 low.

What the market analysts are craving right now is data, in particular forecast earnings data, as that is the key input into forming a valuation. Right now, there is not a lot of that data available as even business owners don’t know what their future is going to be as it is being determined by Covid-19 and we don’t really have a very reliable template as to how this plays out.

The last time we confronted something similar was the Spanish Flu Pandemic of 1918 and nobody can remember how that one played out. But what we all know is that we survived it just in time for the great depression and we survived that just in time for the Second World War and yes, we got through that one as well. So, I am confident we will get through this too.

We are looking for information that in the first instance shows things, at least economically, are not getting worse, i.e. trying to find the economic bottom, to validate this is to then provide a basis for investment. What I can say with a fair degree of certainty is that by the time we see this the markets will already have rallied and the bottom will have reached sometime prior. Look for the indicators that the economy is recovering - you won’t be first in but you will be re-entering (assuming you were out of the market) the market with a reasonable basis.

10. Are there any particular strategies we should be talking with our Financial Adviser about now in terms of protecting our capital position?

It is at times like this, i.e. after and probably during a market shock, that we all do the mental arithmetic, how much have I lost and could I have done anything to mitigate that loss? How smart does cash look right now after being on the nose for so long?

We all would like someone to ring a bell just before the market falls and again at the bottom for us to get back in. We all know that doesn’t work. But there are strategies and ways of investing that are able to change the positioning of the investment portfolio in response to market movements that can help ‘smooth the ride’.

Most of the time being invested in a diversified portfolio of assets including shares, property bonds and cash is appropriate to achieve your goals but at times of market dislocation it would be good if the portfolio could be adjusted to, as we put it, soften the blow. And then participate in the recovery once underway. Essentially, still get to the same destination but hopefully with less volatility and anguish.

The traditional approach does work fine and will enable you to achieve your goals but in this environment of historically low interest rates maybe this is a time to talk to your adviser about portfolios and products that take a more dynamic approach to risk management in achieving your outcomes. With almost no income return from bonds and Term deposits now, stable income sources and capital management is more important generally, and for retirees in particular.

This information is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Please consider the appropriateness of the advice, in light of your own objectives, financial situation or needs, before acting on the advice.

This information and any advice in this website is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. It does not represent legal, property, tax, credit or personal financial advice and should not be relied on as such. You should obtain advice relevant to your circumstances before making decisions in relation to any matters discussed. You should obtain and consider the Product Disclosure Statement for any product discussed before making a decision to acquire that product. The case studies are hypothetical, for illustration purposes only and are not based on actual returns. You should seek specialist advice from a tax professional to confirm the impact of any advice on your overall personal tax position. Taxation information is based on our interpretation of the relevant laws as applied at the date of this communication. Nothing in this website represents an offer or solicitation in relation to property, securities, investments, financial services or credit in any jurisdiction. While every care has been taken in the preparation of this information, it may not remain current after the date of publication and Infocus and its related bodies corporate make no representation as to its accuracy or completeness.