As the coronavirus crisis stretches into its fifth month, the uncertainty surrounding the impact of the pandemic on public health, the global economy and the value of financial assets remains elevated. The incredible swings in financial markets are unlike anything we have seen before, exacerbated perhaps by the popularity of passively-managed tracker funds and algorithmic trading but also by the absence of few, if any, historical precedents to guide market participants through this crisis.
Within the space of six weeks, the MSCI All Country World Index has fallen by 33% and then rallied by more than 10%. Meanwhile, in fixed income, signs of stress in the corporate bond market have been eased to some extent and the last week been a record for bond issuance, as central banks have stepped in to buy corporate debt. Such has been the level of support provided to the bond market that we have even seen Carnival, the world’s largest cruise operator, look to tap demand from bond investors in recent days, something that would have been unthinkable just a few weeks ago.
And there is good reason for the improvement in sentiment. As referenced above, support for the financial system, be it from central banks or from governments, has come in unparalleled size and with unparalleled speed. Reports from China of the beginnings of a normalisation in economic activity provide encouragement for the rest of the world that the virus can be brought under control, as do signs of a slowdown in new cases in countries like Spain and Italy.
However, considerable uncertainty remains. While the depth of the downturn is highly likely to be significant, its duration, which is arguably more important to understand, is harder to predict, not least because the inadequate level of testing in most countries makes it difficult to know the true number of cases around the world. The number of confirmed cases passed 1,000,000 on Thursday, however, some have suggested that the true figure could be an order of magnitude higher. Indeed, a study released this week by some of the UK government’s scientific advisors at Imperial College estimates that between 1.2% and 5.4% of the UK population may have been infected by the virus by 28 March, that is a figure as high as 3.5 million versus an official number of approximately 34,000 confirmed cases.
The shape of the recovery is also unclear and will be heavily influenced by the success of government efforts to prevent the large-scale collapse of businesses, particularly those of small and medium size. The ability of companies to resume normal trading and bring back staff that have been furloughed will prove crucial in supporting consumer confidence and the speed at which the economy is able to recover.
The make-up of the economy may also be different from before the crisis. We wrote last week on changing short-term consumer preferences, but there will be long-term implications. Some expect a more cautious consumer, even once a full economic recovery has taken place, however, if post-war periods are anything to go by, then this has historically not been the case, with the 1920s and the 1950s both periods of strong consumer spending.
The crisis may also support efforts to decarbonise the energy sector, with investments in oil assets likely to be structurally lower going forward, not least because the availability of financing to the sector may have been permanently impaired, creating a significant barrier to entry. There is also the potential that some of the lost demand for oil and its associated products never returns post-crisis if people travel less and work from home more. Additionally, the oil majors have used the crisis not to row back on plans to decarbonise their own businesses but in some cases doubling down on them, with Shell, for example, last week setting out its ambition to become a net zero emissions company by 2050.
Judging what all this means for the oil price over the medium to long term is fraught with difficulties. However, current prices are currently below industry cash costs which historically has provided a floor from which a recovery occurs within a number of quarters. Assuming demand begins to normalise from the second half of the year, planned and unplanned reductions in supply will help to rebalance the market and may support prices through the end of 2020 and into 2021. Indeed, the Brent crude futures curve indicates that the market is forecasting a recovery in price to almost $40 per barrel by the end of 2021.
There will be an economic downturn from the coronavirus crisis, that we can already see and indeed financial markets have reacted to that, but there will also be a recovery. And the companies that prosper the longer-term are those that first have the financial strength in order to survive the crisis, second, offer products and services for which there will be enduring demand, third, have a strong competitive position in the provision of these products and services, and fourth, successfully position themselves to benefit from structural growth trends.
Estimating whether a company meets the four requirements outlined above, is, in our opinion, easier and arguably more important than estimating the exact outcome of the current crisis and therefore we continue to focus our attention on those areas, while acknowledging that there are things that we cannot possibly know, or accurately predict.
Should you have any questions about anything raised in this article, please don’t hesitate to contact us via email, or on 0207 337 0777.
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