Our ongoing commentary on the global economy and financial markets

Keep Calm and Carry On – Part II

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Keep Calm and Carry On
12th March 2020
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Keep Calm and Carry On – Part III
6th April 2020

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Simon Lewis, CEO of Partridge Muir & Warren, provides the latest instalment of his ongoing commentary regarding the global economy and financial markets.

As much of the world descends into what will hopefully prove to be a temporary abyss as a result of the coronavirus (COVID-19), we are experiencing a pandemic of investor panic.

In the UK, the announcement that schools will close tomorrow clearly illustrates that we are accelerating down the UK government’s pathway to a total lockdown, much like the rest of Europe and most likely, in due course, the US.

Financial markets have continued to lurch downwards as the human and economic toll of the COVID-19 pandemic grows. Each time we receive an announcement of further stimulus by either a government or central bank, the ensuing rally in financial assets is soon reversed. It seems that the current psychology of investors is to sell the rally rather than buy the dip.

At times like this it is important, however difficult it might be, to retain a sense of perspective. It is hard to believe that the massive financial stimulus already announced and the further stimulus that has now been implied, and in many cases promised, will not be sufficient to enable the global economy to survive and recover. However, in the meantime, the symptoms of distress are increasing and the health of the global economy is deteriorating. It may be on life support but it will not be allowed to die, because without it our social fabric will disintegrate.

There are some glimmers of hope, which I shall get to later in this article. We are not totally reliant on governments and central banks to save our society; in the long run, science will play an equally if not more important role.

In the meantime, investors have been in a ‘sell everything’ mode. Gold has traditionally been viewed as a safe haven asset but has failed to resist the downward momentum of asset prices and is currently trading around 13% below its peak over the last 12 months.

The financial rollercoaster has been exacerbated by the trade war between oil producers. The oil price is currently at a 17-year low and as demand continues to fall, Saudi Arabia and Russia continue to increase production. If things continue as they are, oil storage facilities around the world will be full to the brim and it is unlikely that new storage capacity can be built quickly enough to accommodate the increasing surplus. As crazy as it sounds, some oil analysts are predicting that the oil price could even turn negative; in other words, producers would pay oil traders to take their oil, which would then be stored pending a recovery in prices. Picture a fleet of full to the brim oil tankers with nowhere to go.

This is a geopolitical act designed to squeeze the life out of the US shale oil industry. It simply cannot survive with oil prices at this level and the two main protagonists of this conflict sense an opportunity to remove a major competitor from their market.

However, in the long term, their tactics are likely to prove counter-productive. They might succeed in bankrupting much of the US shale oil industry but the infrastructure to extract the oil, for example wells and pipelines, will remain and the companies that acquire those assets will have a much lower debt burden than is currently the case. As a consequence, the companies that rise from the ashes of this sector will be able to produce oil more cheaply than their predecessors. In other words, Russia and Saudi Arabia will end up with even stiffer competition from the US in the long run.

Some clumsy comments from ECB representatives generally, and Christine Lagarde specifically, have caused turmoil in certain European government bond markets, particularly Italy and Spain. A positive consequence of this is that European politicians are finally facing up to the need to issue Pan-European debt, removing much of the default risk of individual nation states that has caused panic and reduced liquidity in the less well rated countries.

The one asset that has benefited from this carnage is the US dollar, which is now the de facto safe haven currency. In contrast, the pound has been pummelled and is now trading at a 35-year low against the US dollar.

With all the bad news circulating it is sometimes easy to overlook the rays of light, however fragile, that start to appear. Remarkably, in only a matter of months, a number of potential vaccines for COVID-19 have been developed and are already undergoing human testing. It will take time, firstly to prove their effectiveness then to manufacture sufficient quantities and thereafter to vaccinate at least the vulnerable sections of populations (the elderly and the sick).

In the meantime, it is very good news indeed that the UK appears to have invented a workable antibody test. This is a potential game changer because one of the main difficulties of dealing with COVID-19 is that many carriers are asymptomatic.

One of the main concerns of investors is the uncertainty about when the draconian measures, which are grinding much of the global economy to a halt, will be lifted. The ability to identify those who already have an immunity to the disease will surely bring forward the point at which such measures of control can start to be lifted and the global economy allowed to start moving again. The shorter the period to this point, the less the economic damage and the sooner investor confidence will recover.

So, if we believe that governments and central banks will prop things up in the meantime, we have to accept that the result will be a significant shift in debt from the private to the public sector. The realisation of this is already having a negative impact on government bond markets. But government bond investors need to be realistic. There must surely soon be an acceptance that governments are more than capable of amortising huge amounts of debt over a long period. Yes, in many ways it is kicking the can down the road but right now there is no other option.

These are dark times but we must all have confidence that things will get better. Financial markets are fixated by the problem and have not yet accepted that there will be a solution. But a solution will come. Governments have no choice but to deliver on their promise of doing ‘whatever it takes’. PMW client portfolios are exceptionally well diversified and when that time comes, those portfolios are ready to participate in the recovery that will follow. Until that happens, we need to remain calm and focus on the most important things in life; our health, our family and our friends.

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