IN THIS WEEK’S BOTTOM LINE
CONTRIBUTED BY GIELIE FOURIE| OVERBERG ASSET MANAGEMENT
The Coronavirus Disease 2019 (Covid-19), is impacting negatively on the world stock markets. It is a Black Swan event. Markets experienced one of the worst and most volatile times in history. The Dow dropped 28%. The VIX, a volatility index, spiked from a figure of 12 to 82, its highest level ever. There was blood in the streets.
A BLACK SWAN EVENT: A Black Swan event is defined as an improbable and unforeseen event. Covid-19 was a Black Swan event – nobody saw it coming. In January 2020 analysts from JP Morgan, the big American investment bank, declared the USA economy recession-proof. They learned the hard way that all the economic modelling in the world is futile if it can’t anticipate the one variable that matters most – an international shock, like Covid-19.
The Dow Jones has dropped more than 28% - firmly in bear market territory. Despite this big drop many economists think it is premature to declare a USA recession. A bear market is not a recession. What did investors do? They flocked to one of their traditional safe havens, bond markets. They drove the 10-Year Treasury Note down to an all-time low of 0.318%.
SOUTH AFRICA: SA is firmly trapped in a vice grip – on one side a technical recession, on the other side a bear market. We have had two consecutive quarters of negative growth, causing a technical recession. The JSE has dropped more than 30%, causing a bear market. We believe that we will survive and emerge stronger and wiser out of this. We have experienced recessions and bear markets before.
OUR CLIENT PORTFOLIOS: In a letter to our clients on Friday, we explained that this is not our first experience of a big market drop. Our portfolios are diversified and balanced to withstand market volatility. Our portfolios have dropped much less than the market – we have comfortably “outperformed” the market.
STRONG BALANCE SHEETS PROVIDE A MARGIN SAFETY: It is important to note that this crisis is not a financial crisis. It is an “uncertainty” crisis. Banks in the USA currently have the strongest balance sheets in history. The recession of 2008/9 was triggered by a financial crisis. Banks were in trouble. In 2008 Bear Stearns, a big investment bank, and Lehman Brothers, the fourth-largest investment bank in the USA, filed for bankruptcy. Lehman remains the biggest bankruptcy in USA history. In November 2008 USA markets dropped 25.2%.
This time is different. Balance sheets are strong. Companies like Apple and Berkshire Hathaway carry billions in cash. There are notable exceptions – the USA shale oil sector is vulnerable. Economists agree - if there is negative growth, it will “only be temporary”. The long bull-run of the Dow Jones, from 2008/9 to its peak in Feb 2020, posted a gain of 351%. By last night, 16 Mar 2020, the Dow had lost 28% from its recent peak - technically a bear market. The dark clouds have silver linings. We highlight a few positives.
POSITIVE No 1 - CORONA’S POSITIVE SPINOFF: Covid-19 has an unexpected positive spinoff. It is as if the world sees it as a force majeure, or an act of God. Several countries have declared national disasters/emergencies. Seldom before have people across different political and religious perspectives, joined hands to fight a common “enemy”. Petty differences are set aside. It has the potential of bringing people closer together. As a temporary measure, international events have been cancelled, travelling has been banned, schools are closed. If they err, they choose to err on the safe side. The public accept it in good faith. These things are unheard of. Internationally, governments are introducing emergency stimulus measures. To prevent another recession, the Federal Reserve had already cut interest rates by 50 bps. To further calm financial markets, they followed it up with another drop of 1% on Sunday, driving Interest rates down to between 0% to 0.25%. In addition, the Fed has launched a massive $700 billion quantitative easing program to shelter the economy from the effects of the virus. Sadly, due to grand corruption at the highest levels of government, SA cannot afford the luxury of stimulus packages, however modest. We hope to see an interest cut on Thursday.
POSITIVE No 2 – LOW OIL PRICES: Totally unrelated to Covid-19 is the big drop in the oil price. Last night Brent crude traded at $30.40 per barrel, prices last seen in March 2000, 20 years ago.We can thank Vladimir Putin for this windfall. Putin doesn’t see any merit in Opec’s strategy of cutting oil production. Putin “smells blood” in the vulnerable USA shale oil sector – he wants to close them down. Low oil prices will hit rich oil producing countries - Sasol will suffer.
But for the rest on the world, low oil prices are good news. Our industries are heavily dependent on oil. Lower oil prices will lead to lower inflation. Retail prices could drop, or they may rise at a slower rate. Consumers will have more disposable cash. Consumer spending drives 60% of our GDP. Consumer confidence will pick up. Our economy will benefit.
POSITIVE No 3 – LOW SHARE PRICES: Share prices on the JSE were low even before the start of the bear market. Today prices are 30% lower. The average dividend yield of the JSE Top 40 Index, excluding Naspers and Prosus, is 6.84%, the Earnings Yield is 9.98% and the Price Earnings ratio is 10.02. The market has not been so cheap in decades. It is a buyers’ market.
WHEN CAN WE EXPECT A RECOVERY? Typically, economists have divergent opinions. Economists, who we have learned to trust, expect it to be all over within six months. Their proviso is that no new Black Swans emerge. Finally, when economists/politicians make predictions, heed these words of USA mathematician Claude Shannon: “We know the past but cannot control it. We control the future but cannot know it.”
Read More: Overberg Market Report 17 March 2020