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Sharemarket Lessons from past Crises

Tuesday, March 3rd, 2020
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Since mid-January, the Coronavirus COVID-19 has increasingly dominated daily news.

For a time, the spread of the virus didn’t dent investor sentiment. Indeed, on February 20, the key indexes of US and Australian share prices hit all time highs; bond yields had held fairly steady; exchange rates were said to be “boring”; and in Sydney and Melbourne talk was turning to the renewed surge in house prices.

However, attention has now switched to the disruptions, uncertainties and fears that could result from the Corona virus. The word “outbreak” was replaced, first by “epidemic” and then by “pandemic”.

Global growth prospects were revised down, as gloom heightened on China’s capacity to contain the virus and the infection spread to other regions (including Europe, the Middle East and Korea); travel plans were cancelled on a great scale; and “globally integrated supply chains” were disrupted.

Over five days, average share prices in the US plunged by 10 per cent; many investors and commentators became spooked by fears of an imminent bear market in shares. Bond yields fell, to record low levels.

The value of the Australian dollar dropped a little further to 11-year lows.

Financial crises are a frequent occurrence in investment markets. In the past 25 years, these crises were experienced:
● In 1997 and 1998, the Asian financial crises.
● In 1998, the Russian crisis; and the problems of Long-Term Capital Management.
● In 2000, the tech wreck that resulted from the dot.com crisis.
● In 2001, the terrorist attacks of September 11 in the US.
● In 2002, the corporate fraud exposures in the US, including Enron.
● In 2008 and 2009, the global financial crisis; and fears of recession in Australia.
● In 2010 and 2011, sovereign debt crises in Europe.
● In 2013, the “taper crisis” in US bonds.
● In late 2015, fears the US would “double dip”; and of China having a “hard landing”.
● In 2016, Brexit; and the negative initial response to Donald Trump’s US presidential win.
● In 2018, an inflation scare in US; then a plunge in US shares on fears the US cash rate would be increased further.
● In 2019, recurring concerns that the US yield curve inversion was forewarning an early US recession.

When a financial crisis occurs, many investors panic. And that’s understandable: the outlook is said to be dire; and frequent reference is made to the deep and lasting losses suffered in earlier crises. But in a high proportion of financial crises, effects turn out to be contained and short-lived.

Readers might like to look back at the list of the financial crises of the past 25 years, and separate the individual crises into two buckets: one labelled as “real crises” (where investors did need to bunker down for a lengthy period); and the other called “false crises” (which were short-lasting and gave investors opportunity to buy quality assets cheaply).

Of course, it’s not always possible to pick, at the time, how serious the crisis will be. With the advantage of hindsight,only two of the 17 episodes on my list — the global financial upheaval of 2009 and the dot.com problems in 2000 — would now be seen as real crises. The others, if remembered at all, would be categorised as false crises.

As well, investors need:
● To maintain a sensible allocation to safe assets to cope with unpleasant surprises, even when cash and bonds carry low yields. This is particularly important for people newly retired and starting to run the stock of assets they have accumulated.
● To keep in front of mind the observation Paul Samuelson, a famous US economist, made in 1966: that the US sharemarket had predicted nine of the past five recessions.
● To allow that the direction our sharemarket takes is usually determined by US shares — not by Australian economic conditions or policies. Also, that a recession in the US tends to cause a sharp and sustained downturn in share prices globally.

Recognise that, while each bear market for shares starts with a sharp sell-off, not every big drop in share prices begins the onset of a bear market.

Can we learn from earlier epidemics? Globalisation has added to the risks of global spread of diseases — but understanding how to contain a virus through vaccines and controls on people from affected areas has also come along way.

I do not think there is much to be learned by looking at the details of the other major plagues of the past century or so: the “Spanish flu” of 1918 and 1919 (which killed 20-50 million people worldwide); the “Asian flu” in 1957-1958 (with deaths of one to two million); the “Hong Kong flu” in 1968-70 (a million deaths); SARS in 2002-03 (about 0.9 million deaths); and the “Swine flu/Mexican flu” of 2009 and 2010 (with deaths of 600,000).

It’s too early to take a considered view on how widely the Coronavirus will spread, how many people will suffer, or how it will affect the world economy.
A sensible strategy for investors could be:
● To keep a close watch on the spread or containment of the virus as vaccines and better quarantine controls are developed.
● To allow that some aspects of the outlook for shares will probably remain positive, such as low interest rates and a global economic stimulus.
● To await further sell-offs in shares before buying back into the sharemarket.
● When it’s time to return to the market, to perhaps do so for a while by “averaging in”.

 

Don Stammer is an adviser to Stanford Brown Financial Advisers. The views expressed are his alone.
don.stammer@gmail.com