COVID-19 continued its global spread last week, as policymakers and health officials began to spell out some highly disruptive plans; meanwhile, infection numbers continued to rise, and are now approaching 110,000 cases. As a result, investors sought out the safety of government bonds; the 10-year US Treasury yield dipped to below 0.5% while, in the UK, 10-year gilt yields dropped to just 0.1%. (Yields move inversely to prices.) Stocks, meanwhile, stumbled through the week. The FTSE 100 ended down, but the S&P 500 had all but recovered by the time of its Friday close.
However, dramatic falls in early trading this morning quickly dwarfed last week’s moves, after the price of a barrel of Brent crude fell 27% in early trading to just $33, the result of Saudi Arabia increasing production even as global growth fears weigh on the mood. Tom Hemnant, Senior Credit Analyst at Invesco, manager of the St. James’s Place Corporate Bond fund, believes it is likely to remain in the $30s for the short term. But that’s not necessarily all bad news for long-term investors.
“We are experiencing market volatility not seen for a number of years, exacerbated by the latest decline in the oil price and in US Treasury yields,” said Tom Beal, CIO at St. James’s Place. “As painful as this may seem in the short run, it is in markets like this that active managers earn their crust. A number of our managers have told me that indiscriminate selling by passive funds has created opportunities to buy high-quality companies at lower prices. Meanwhile, our own diversified portfolios are holding up relatively well, as diversification is a great insurance.”
The notable exception to last week’s general trend, strange as it may seem, was China. Last Thursday, China’s CSI 300 struck a two-year high, rising more than 2% in a single day’s trading; the week as a whole saw gains, too. The cause? A slowing in the rate of infection in China, and pledges of fiscal and monetary support from Beijing.
“The number of confirmed cases announced recently has actually been very encouraging, particularly in China outside of Hubei,” said Martin Hennecke, Asia Investment Director at St. James’s Place, last week. “Zhejiang province lowered its epidemic emergency response level on Monday, after more than 15 other provinces had lowered their response level earlier. Half of patients have now recovered. We believe these are key factors behind the recovery in mainland stock markets.”
There are localised factors, too. The composite index in Shenzhen’s for small-tech companies has been a standout performer globally in 2020, gaining some 12% because stay-at-home policies benefit its constituent companies. The Shanghai Composite, on the other hand, is udown. Expectations for broader Q1 corporate profits in China are currently “abysmal”, according to Gavekal Dragonomics, a consultancy. So, what kind of 2020 GDP growth do these varying stories add up to?
“Looking at China, by our initial estimates, the loss to the Chinese economy will be approximately 0.5% to 1% of GDP from 2020 baseline growth,” said Loomis Sayles, manager of the St. James’s Place Investment Grade Corporate Bond fund. “The quarterly impact could see GDP growth fall from 6% in the fourth quarter of 2019 to close to zero in the first quarter of 2020 before a sharp rebound. As we see it now, annual growth in 2020 will likely be in the low 5% range instead of closer to 6%.”
Elsewhere in the world, the virus’s spread may be at an earlier stage in the its trajectory, but that doesn’t mean investors should panic. After all, China has already seen the rate of case rises drop.
“In our own assessment, we are inclined to believe that in weeks and months to come, everyone will learn to live with the existence of COVID-19 as a fact of life,” said BlueBay. “Everyone will calm down and carry on and life will return to normal. However, to reach this point, there probably needs to be more hysteria in the short term until policymakers and public opinion begins to adjust. Financial markets will try to be forward looking, but at the moment there is just too little visibility and therefore current levels of volatility may persist for a time with risk reduction the order of the day.”
Making the cut
The monetary side of the equation is being considered around the world, and in haste, as central banks in major economies around the world contemplate the likely hit to domestic GDP growth – and to trade.
Some 40% of world trade is accounted for by just five countries: China, South Korea, Japan, Germany and the US. The first three of these are already facing virus crises, prompting central banks to consider remedial action.
One central bank to move fast was the Federal Reserve, which last week lowered interest rates by 0.5% in a unanimous decision. It was the Fed’s largest emergency rate cut since the global financial crisis – and provides a cue for the broader direction of travel, especially given G7 finance ministers jointly pledged last week to use “all appropriate tools” to keep growth on track.
Indeed, the Bank of Canada cut by the same margin and The Reserve Bank of Australia by 0.25%. Capital Economics now forecasts that the Bank of England will cut rates from 0.75% to 0.5% in the near future, and that the UK chancellor will offer extra measures to help households and businesses in this week’s Budget.
When Boris Johnson campaigned in the general election, the focus was Brexit, rebalancing Britain and supporting the NHS. But events have a habit of playing havoc with a prime minister’s plans. While Brexit negotiations continue and HS2 looks set to go ahead, COVID-19 is undoubtedly the issue of the day. That is increasingly becoming the case in the US, too, despite Donald Trump’s attempts to downplay the virus, although Joe Biden’s recent surge in the Democratic primaries has been competing for the headlines.
Although the global spread of coronavirus is likely to force the Treasury to defer any big announcements until the autumn, we could still see some important changes in the Budget this week.
One that may get a mention is the tapered annual allowance.
Under the taper rules, anyone earning more than £110,000 is at risk of having their annual tax-free pension saving allowance reduced from £40,000 to £10,000 a year. Anything over the saving allowance is subject to a tax charge.
The tapered annual allowance has proved toxic in its complexity for high earners, creating many more problems than it solves – most evidently for the NHS. Faced with the prospect of paying extra pension tax charges, thousands of doctors have reduced their work commitments, leaving patients with fewer medics and longer waits for treatment.
Given that the NHS is now likely to come under greater strain from the coronavirus outbreak, Rishi Sunak is expected to take steps to relieve the pressure by raising the point at which the taper starts from £110,000 to £150,000.
But the British Medical Association (BMA) has said that simply raising the taper threshold would not solve the workforce problems caused by the taper.
“For a lot of people, raising the taper threshold will not give them the full reassurance they need to take on extra work,” said Vishal Sharma, head of the BMA’s pension committee.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
In The Picture
The coronavirus offers plenty of excuses for market participants to make their exit – and many have done just that. What should a long-term investor do?
The Last Word
“You have brains in your head. You have feet in your shoes. You can steer yourself any direction you choose. You’re on your own. And you know what you know. And you are the one who’ll decide where to go…”
Dr Seuss, who was born 116 years ago last Monday
BlueBay, Invesco and Loomis Sayles are fund managers for St. James’s Place.
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