As the effects of the COVID-19 pandemic intensify, we are frequently reminded that we are in unprecedented times – particularly from the financial market perspective. This event bears very little resemblance to “normal” crashes which generally have similar origins: credit squeezes, high-interest rates, commodity turmoil, and so on. This one is different.
Caused by a toxic blend of coronavirus coupled with a conventional trigger – a sharp fall in oil price – this crash, and its consequences, are difficult to predict.
What’s most uncertain is whether this crash will damage capital market structure, and whether we are at the precipice of a financial crisis.
Here’s what we know
According to the known facts at this point in time, threats surrounding coronavirus appear to be linked to factors such as age. Reports indicate that older individuals who contract the virus have a higher rate of mortality – so there is real fear. This fear impacts the immediate behavior and actions of this group. It also has the potential to significantly impact Australia’s future demographic profile – which in turn has consequences for relevant industries that cater to this group.
In simple terms, a sudden downturn for industries relying on this segment – followed by sluggish recovery of consumer spending – has strong potential to create conditions for increased business and industry failure (the cruise industry is definitely feeling the pressure of this scenario currently).
What does this mean?
If industry failure extends to the point that it causes instability across the wider market, it can impact a country’s banking system and financial structures. At that point – the telltale signs of a crash (and all the normal crash rules) will be evident.
Generally, this type of crash will cause structural damage. Italy is currently experiencing structural damage, and is almost certainly heading into a devastating crisis that is likely to affect the whole of Europe.
Looking to the US
In an effort to provide some perspective – so far, coronavirus appears to have impacted the US market in a similar way that it has the Australian market. However, the US market alarm bells are ringing much louder – particularly in the credit arena.
The US has the biggest corporate bond market in the world – and a substantial chunk of that market comprises debt securities that have a higher degree of risk compared to top-rated companies.
The largest part of that higher-risk market are bonds issued by energy companies led by the shale oil industry. The recent collapse in oil price has caused a large increase in the cost of borrowing, not only for the energy sector, but also in the entire mid-range corporate sector.
If oil prices recover – or if Trump is smart enough to contain the trouble in the shale oil industry – then there’s a chance that long-term damage will be minimized.
But with every day that goes by, the US debt markets grow increasingly nervous and the market slashes the price of bank shares. These are knife-edge times.
How does this affect Australia?
US and Australian banks are down 40-50%. This is flowing into Australian securities and property trusts, and also infrastructure assets.
The volatility of the market relating to mid-range corporate debt coupled with the uncertainty surrounding a global pandemic is causing tension to run high. And this is what makes the situation so dangerous.
What this will mean in coming days, weeks and months for Australia is unclear. In reality, the true impacts on the market may be hard to detect at first. For example, flow-on to the real estate market may be delayed because home-buyers are generally a younger demographic – and they aren’t the key segment that are immediately reacting to (or suffering from) the pandemic. So, behaviour change may be slower.
However, if like Italy, we start to see structural damage in our capital markets, then house prices will inevitably fall and the crash will be evident in a more conventional fashion.
But there are glimmers of hope amidst the uncertainty
Developments around vaccines are bringing us closer to winning the fight against the virus. Chinese markets are showing early signs of recovery. The US credit markets have potential to contain the damage. It’s suspected that the investor reaction to this crash will leave us with a world awash with cash (albeit, with substantially devalued listed asset prices).
Where this leaves us is with market conditions closer to those that we are familiar with (in a post GFC world) and that we can build on.
While waiting for the fog to lift, it’s wisest for those with an established investment strategy to refrain from reacting. Stick to your existing approach – and make considered moves around rebalancing. While the immediate outcomes of this event are unpredictable, the long-term outlook for market recovery is evident – and should provide some comfort.
And right now, we’re all in need of some comfort.
Need some help or got questions? Contact your local Bentleys advisor now.
Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.