2020 will forever be the year COVID-19 gripped the world and the sent global equities into free-fall.
Although many of us are not strangers to stock market crashes – there are some unprecedented circumstances around this particular COVID Crash which suggests that it may be more malignant and less temporary than its predecessors – leaving a lasting change on investor behaviours whilst hindering any chance of ‘quick knee-jerk recovery.’
Some prudent questions Investors should be asking themselves given the current circumstances…
What are the medium to long-term of effects of sustained quarantine?
The world has never endured a sustained quarantine where global economies have been stripped to bear essential goods and services only. A sustained quarantine – more aptly, sustained unemployment - could have devastating and permanent effects on both the micro and macro economy.Unlike the recent COVID19 Crash, immediately following the 2001 and 2008 Crashes, Consumers around the globe could return to work the next day and continue grinding the gears of their respective economies – with unemployment peaking at 7.1% and 5.9% in both 2001 and 2008 respectively(https://tradingeconomics.com/australia/unemployment-rate)
Treasury Data in Australia indicates that without the JobKeeper allowance unemployment rate could be as high as 15% as of April 2020 – for some context, during the Great Depression levels of unemployment hit 20-25%.
Is unemployment artificially supressed due to JobKeeper allowance?
Unemployment is a lagging indicator – Q1 unemployment was 5.1% which is forecasted to rise approximately 10% in the June quarter (https://www.abc.net.au/news/2020-04-13/coronavirus-unemployment-covid-19-treasury-figures-jobless-rate/12145542
Recipients of the JobKeeper Allowance are classified as employed according to ABS reporting - which leaves room for speculation that it could well in fact be a lot higher.
Moreover, there will a prolonged period between when the Government can no longer afford to continue JobKeeper Allowance payments and when we see aggregate demand restored to pre-virus levels.
The longer this period the higher the potential unemployment rate will climb – especially pertaining to small to medium sized businesses who cannot afford to absorb demand lag.
Is there sufficient room for effective Monetary Stimulus?
In short, NO.
The Modern Monetary Theory adopted by Central banks the world over, have become solely reliant on the swift adjustments of interest rates to remedy any economic downturn.
However, it seems this trend is simply no longer viable.
During Recession, Central Banks reduce interest rates and increase the Monetary Supply - through Quantitative Easing – which in turn increases inflation and drives up asset prices. This has become known as expansionary monetary Policy – and has been the Get-Out-Jail-Free Card for central banks for the past 40 years.
However, nothing is free in this world…
Expansionary monetary policy has ultimately increased global debt and has now pinned global interest rates to near zero.
In May of last year Ray Dalio, CEO of Bridgewater Hedge Fund, described the diminishing effectiveness that Quantitative Easing and lowering interest rates has on stimulating an economy in downturn. Ultimately foreseeing a monetary apocalypse in which there would be an i) economic down-turn and ii) where interest rates would be pinned to zero.
Lo and behold here we are 1 year later….
It may be quite dry to those of other affinities, but I encourage you all to read it: https://www.linkedin.com/pulse/its-time-look-more-carefully-monetary-policy-3-mp3-modern-ray-dalio/
Dalio goes on to detail that in this scenario there is little to no room to lower interest rates and that QE effort would only lead to hyperinflation. He describes how Governments and central banks would need to move to a new version of Modern Monetary Policy – which he calls Monetary Policy III – more reliant on fiscal stimulus rather than monetary.
As investors, you do not need to need to concern yourselves with the minutiae of this inevitable cataclysmic shift in global monetary policy – all you need to know is that such a change would be lengthy, arduous and will riddle global equities in speculation for a continued period.
Can we find refuge in Gold and Silver?
To an extent…
Investors tend to change asset classes depending on the perceived risk in the markets. Stocks are considered to be riskier assets than bonds, precious metals and cash. Therefore, ‘a market where stocks are outperforming bonds, precious metals and cash is said to be a risk-on environment’. https://www.investopedia.com/terms/r/risk-on-risk-off.asp
Precious metals are what we call Inflation hedged assets which means they are risk-off and as such are negatively correlated to stocks.
Whilst a portfolio which is negatively correlated to the stock market is great during crashes, it is adversely susceptible to quick changes in investor sentiment should the market consolidate sideways – which is what can be expected as the stock market treads water or tapers back-and-forth whilst trying to find its bottom.
Investors would be wiser to achieve a portfolio that is NON-CORRELATED as opposed negatively correlated to the equity market.
Instead of backing a horse to win or not to win – it’s sometimes best to bet on sport or some other unrelated event.
Since winding down our ASX portfolio last year, we have had been steadfast in achieving returns uncorrelated to the Global Equities – we feel our Swing Strategy has best achieved this.
Here is another great source of uncorrelated assets from Guggenheim Investments: https://www.guggenheiminvestments.com/mutual-funds/resources/interactive-tools/asset-class-correlation-map
Is Property a viable alternative in Australia…?
High unemployment leads to reduced household income which ultimately reduces serviceability of debt for the average Australian investor – ultimately causing a drop in housing demand.
Historically, demand-driven crashes are quickly recovered provided there are no extraneous inhibitors of demand… such as sustained employment and the stoppage of immigration.
Previously under these circumstances, the RBA would cut rates to increase the availability of credit which would inturn prop up demand – however with current cash rate set at 0.25% leaves little room for a rate cut, with evidence supporting “monetary policy transmission of rate cuts is indeed weaker when interest rates are persistently low”. https://www.rba.gov.au/publications/confs/2017/pdf/rba-conference-volume-2017-borio-hofmann.pdf
More concerning is that the key driving force behind Australian Residential housing market strength has been Australia’s net immigration.
It’s no secret that migration increases house price.
“The pick-up in immigration coincides with Australia’s most recent housing price boom. Sydney and Melbourne are taking more migrants than ever. Australian house prices have increased 50% in the past five years, and by 70% in Sydney.” (https://theconversation.com/how-migration-affects-housing-affordability-92502)
One can only speculate how long Australia’s border will be closed and what the immediate effects a zero-immigrant economy will have on residential housing market…
Coupled that with a potential 15% unemployment rate and ineffective monetary stimulus – we may see a slide in both demand with a potential increase in supply as Australian Households seek to ration assets.
‘Some economists, such as AMP’s Shane Oliver, estimate that prices could fall as much as 20% if the recession lasts more than six months’ https://www.theguardian.com/australia-news/2020/mar/20/australian-housing-market-will-hit-the-wall-in-coronavirus-recession-experts-say
What should my portfolio look like in 2020?
A bear market is hard to predict – it’s turn-around even more so. One thing that can be predicted with confidence is the prevalence of market volatility as investor sentiment switches back and forth from risk-on to risk-off.
The dynamic shifts between risk-on and risk-off sentiments require portfolios which are actively traded and directionally unbiased – can profit in up and down markets.
Walker Capital’s current strategies are actively traded currency and commodity portfolios. It is our objective to achieve returns uncorrelated to the stock and property markets in order to provide investors opportunity to diversify risk and maximise returns.
Whilst there are there are correlations between certain stock indices and currency pairs – provided we actively trades both directions in currency prices the returns we yield are uncorrelated the stock markets.
Our strategies should be considered as an alternative to investments into the stock market given current market conditions