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Caution and cash as virus impact remains hard to measure

5 March 2020

The impact of the Corona Virus is very hard to measure but it will be material in terms of GDP, says Premier Miton’s David Jane. 

Worries about the Coronavirus sent markets into a tailspin as cases were reported in Italy and other countries closer to home and people started to consider the real risks of economic disruption. China is just a little too far away to worry people perhaps. Seemingly as a consequence of the major market setback, the Fed cut rates by 50bps and other central banks have acted also.
The difficulty markets have with an external shock like the virus, is that its impact is very hard to measure.

It is easy enough to point to sectors like travel & leisure and retail and say consumers will spend less, but how much less and for how long.
In manufacturing, supply chains will inevitably be disrupted, and to a greater degree than we yet know, but is it just temporary with deliveries being delayed or will output be permanently lost? Markets hate uncertainty, hence the central bank action.
Where the real difficulties arise is with those individuals and businesses who are not in a position to weather a shock.

Many individuals in China, and indeed much of the western world, live hand to mouth, paid daily or weekly, particularly in those industries most effected near term. A week or two of enforced inactivity can be catastrophic for these households. Hong Kong has therefore introduced an innovative fiscal policy in the form of a HKD10k payment per adult. Nice and simple but arguably easy for them, Hong Kong has no debt and substantial reserves. Other countries may find such largesse more difficult.

Corporate sector issues
Arguably the issues in the corporate sector, at least in as much as they impact markets, are far greater. Corporate debt is very high and concentrated in many of the most impacted industries. The problem with high debt levels is they reduce resilience to shocks, whether for a business or a leveraged investment strategy. What seemed sensible, even clever, when times were good can be terminal in the event of a shock.

The market tailspin may well have reflected a number of highly leveraged investors becoming forced sellers, exacerbated by month-end, compounding worries about the economy. Hence the relatively uniform sell down in risk assets.
What the market is yet unable to assess is the effect on leveraged corporates, as we simply do not have the data to scale the amount of revenue and profit that has been and is yet to be lost.

Lost GDP

In the absence of a quick recovery from here it is safe to say that the impact will be material in terms of lost GDP. In the worst case it could lead to a compounding credit crisis, particularly in Europe, where debt levels are very high and the banking system fragile. On the other hand, things could settle down here and a little central bank easing and government generosity will tide things over.

It is tempting to take advantage of buying opportunities in a few stocks that are largely immune to any economic impact from the virus. The broader picture, however, suggests a continued cautious stance, with Gold and government bonds to protect to the downside and the sort of quality under- leveraged businesses we have been holding for sometime. Absent the clarity required to make a sizeable call we will remain this way, happy to hold significant cash positions until the direction is clear again.

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