Corona Virus Chronicles (IV) - The expanding the sea of red
It is difficult to think how much worse the reaction in the financial markets could now get. But it will get worse.
Financial Market Reaction
It is difficult to think how much worse the reaction in the financial markets could now get. But it will get worse. Markets fell yesterday, despite a realistic and pragmatic approach in the UK. A concerted response from the Bank of England, the UK Treasury and the Chancellor. The FTSE enjoyed a brief respite, but then sunk, along with International bourses as the US Presidential response was seen to be totally inadequate.
This morning is at best a difficult market. To practitioners who have been in the market for decades and worked through a host of challenging conditions, this is yet another completely new experience. On the open, the FTSE 100 fell and within a short space of time was off 400 points, just shy of a 7% drop.
We can write many words on the subject, but right now we must concentrate on how to best protect client’s wealth. Unfortunately, there could be a phase of the virus that brings stock markets to a complete standstill, simply because people are needed to make it all work. This concern reflects across all financial institutions. It is preferable to still be in low risk strategies. Better still in cash. Better yet again in short-dated Gilts.
Thinking about markets, investors may be tempted to try and take advantage of what appears to be very cheap prices.
In stock markets, many investors believe the price is everything and yet on it’s own, the price is nothing. On a standalone basis it provides nothing other than a practical means of transacting in the stock market. However, it is an important sentiment indicator or the currency of a company, that in turn reflects a host of variable outcomes and viewpoints, but it does not really say anything detailed about a company’s underlying financial position. In this market rout, all stocks (and corporate bonds) have been marked lower as investors really do not know how the economics of the virus will affect the value of a Company. In this environment therefore a current lower share price than last weeks might be viewed as a bargain? Time will tell of course and the probability is that in time, these prices will be seen as “cheap”. But there is “many a slip” to be overcome first.
Markets are fretting over companies which have large levels of debt. Deeply indebted companies are being marked much lower and a bifurcation in market performance between those companies with a good credit profile and those with a poor one will soon be pronounced.
Market commentators such as those at Goldman Sachs are reliably counting on another few months of market volatility, which will reflect the prospect of a severe slump in business activity from February through to April/May when the virus effect should be known and start to lessen. They then believe that economies – and therefore stock markets will stage a dramatic comeback. A large V shaped recovery.
However, a period of some 4 months (February to May), marks a time where orders and supply chains dry up at the same time as employees cannot work and more importantly consumers cannot consume, it may be the last straw. Whilst a company can defer supply chains and lay-off employees, they cannot defer interest and debt repayment deadlines. Companies that are deeply indebted are therefore in a perilous position. Corporations that have to meet a near term refinancing of maturing debt programme, or which work under strict lending covenants will be at risk. Some immediately standout from the rest; indebted oil producers for example, or even larger global companies that have embarked on ambitious expansion plans. It is now likely that they will not be able to access finance through the bond market (where issuance has slumped) and also have their bank credit facilities withdrawn at a critical time. Refinance operations are under scrutiny and investors will avoid these companies – their share prices will fall further.
However, it is not known, with any sense of certainty, how far the influence of this problem will affect unleveraged companies. Within the panic of markets, we can understand that high leverage is a problem. The difficulty is that there will be real knock-on risks contaminating financially solid companies.
So, in this time of global worry caused by the Corona virus, “Leverage” is the corporate pandemic equivalent that will lay companies low.
Consequential, unexpected problem areas will undoubtedly occur and as such being safe and very conservative is the right thing to do at this difficult time.
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About the Author
Peter Smart, Head of Investments
Peter has been involved in investment markets since 1985, working within the private client areas of two global banks and for 22 years as the fixed income specialist for the UK Wealth manager, Brewin Dolphin. More recently Peter formed part of the investment team at bridport in Jersey specialising in the provision of specialist, income focussed portfolio’s.