Coronavirus (COVID-19) and the economic downturn – what does this mean?

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From the 20th of February to 27th March, we have seen global markets (as represented by the MSCI World Index) lose 23.83% with Australian markets (as represented by the ASX 100 Index) falling 31.64% over the same period.

Why is COVID-19 causing this market reaction?

There are a number of key reasons why markets took a tumble over the past 2 weeks:

  1. On Wednesday 11 March 2020, the World Health Organisation (WHO) officially declared the coronavirus (COVID-19) outbreak a pandemic. Whilst this had become widely expected, the formal declaration had direct implications for governments and companies;
  2. On Thursday 12 March 2020, The Trump administration banned all flights from Europe entering the US; and
  3. Despite ever increasing attempts, authorities to-date, are failing to give sufficient confidence to markets that impacts to businesses caused by containment measures would be adequately supported in the subsequent economic downturn.  

How governments are responding and efforts in containing the virus are directly impacting the markets. The harsher and stricter measures being implemented by the government, the more immediate the economic damage. This is seen in the banning of European flights into the US and sharp market reaction that followed.

However, governments are forced to implement these harsh measures in order to deal with the crisis effectively, even though it hits the economy negatively in the short term.

How are businesses responding to COVID-19?

Businesses are responding to this as expected, such as cancelling of events, cancelling of travel, essentially keeping their clients and employees from potentially getting infected and spreading the virus. These types of actions by businesses will lead to a slow-down of the economy.

Is a recession likely? And what is the government doing about it?

We are most likely going to see a contraction in economic indicators until June. An economic contraction, also known as recession, refers to a significant decline in general economic activity in a designated region typically recognised over two consecutive quarters of economic decline.

What we are uncertain about is how long this crisis will be and the implications for businesses. Governments are focused on whether they can support businesses to get through this drop in demand so that they do not need to react by cutting down their workforce, leading to or deepening a recession.

On Sunday evening of 22 March 2020, the Australian Federal Government announced a second package of measures worth A$66bn, focusing on supporting employees and businesses through the economic downturn as a result of the coronavirus (COVID-19). You can read more about the stimulus package here. Globally, most major economies are taking a similar approach, combining stimulus with interest rate cuts.

So, what does this mean for investors?

Given the uncertainty of the COVID-19 pandemic, many investors feel the need to head for the exits and ‘cash out’, however over the long-term on average, this is ultimately a losing strategy. The table below shows the difference in annual performance between buying and holding assets (do nothing and ride out the fluctuations) and buying and selling assets based on reacting to the market fluctuations.

The data details the performance of the Australian stock market back to 1993, which saw significant market events, such as the Asian debt crisis, the tech-wreck, SARS, the GFC, and the European debt crisis take place. You can also see in the table the high number of buy/sell transactions which ended up costing investors, particularly when execution costs are factored in.

Market timing covid-19As at 31 March 2019.
Source: Factset. Data details performance of the ASX300 accumulation index from March 1993 and assumes 0.5% transaction costs and no tax in periods where the portfolio was sold, it was then invested in cash – represented by the Bloomberg AusBond Bank Bill index. Past performance is not indicative of future performance.

It’s important to understand this table, as it shows what happens when you react to market fluctuations over 26 years. So, let’s look at two investors with different behaviours as an example.

  1. Amy is a long-term investor, she prefers to buy and hold onto her investments, this is commonly known as riding out the volatility waves.
  2. Belinda is very active in the market and she prefers to trade when the market fluctuates.

Let’s take the last row as an example. Belinda reacts to market changes and when she sees a decline in the market, she will act and sell her assets every time there is a 5% fall in the market. So, if the market is currently sitting at $100, Belinda will sell her assets at $95.

During this time, say the markets continue to fall to $80. After some time, a change happens seeing markets rise. Belinda notices this upward change and decides to buy after the market has experienced a 5% increase, therefore buying at $84. Belinda has come out $11 in front however faces the transactional fees and taxes.

Belinda continues to be very active in the market over 26 years between 1993 and 2019 which saw her generate a long-term annual return of 2.85%, as a result of 74 transactions. Don’t forget there are costs associated with every buy and sell transaction as well as taxes.

On the other hand, Amy hears about the market performance going down, she understands the risks of trying to buy and sell when the market is unstable, so Amy decides to hold onto her investments.

And over the 26 years Amy has taken the same approach through significant market events such as GFC, SARS outbreak etc. Overall, Amy has come out with 9.70% annualised returns and no transactional buy/sell fees.

As you can now see this research has shown from the past 26 years of historical data that long-term investors should not be alarmed about isolated incidents of market volatility and should refrain from trying to time investments based on speculation.

Where you are in your stage of life matters

There’s never a good time for poor investment performance. But some stages in life are worse than others, and the worst of all stage is near the point of retirement.

When you are in the early stages of your working life and building your retirement nest egg, time is on your side. If you experience a bad investment return such as we are experiencing now, you can weather the setback over the long term. Your investment portfolio has time to recover.

Fast forward to your retirement and the fundamentals has changed. Now you are risking a lifetime of savings - savings that you depend on for income after work. If you suffer a series of poor returns in the first few years of retirement, your investment portfolio may not have time to recover. Which means less retirement income.

People call this dilemma sequencing risk – the risk of experiencing poor returns at the worst possible time in your life. Read more about sequencing risk here.

Our advice to investors

While we can point to facts and figures and tables, we all know that people aren’t ‘systematic’ in nature. We acknowledge when markets fall as steeply and precipitously as we’ve seen, there is a very real sense of dread as investors see the decline in value of their portfolios. This is where advice becomes invaluable to ensure an objective and long-term focus in investment portfolios.

Good advice is always recommended, but absolutely essential during these types of market events.

Knowledge is Power
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Perpetual Private advice and services are provided by Perpetual Trustee Company Limited (PTCo) ABN 42 000 001 007, AFSL 236643.

This information has been prepared by PTCo. It contains general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial or other adviser, whether the information is suitable for your circumstances. The tax information contained in this document is not tax advice and should not be relied on as such. This information, including any assumptions and conclusions, is not intended to be a comprehensive statement of relevant practice or law that is often complex and can change. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. To view the Perpetual Group's Financial Services Guide, please click here. Past performance is not indicative of future performance.