In the last quarterly update I expressed some hesitation over broad based market returns in the near future simply due to elevated valuations and the length of the post-GFC cycle. Nonetheless, I would never have predicted that by the next quarterly update not only we would have entered a substantial bear market, but the velocity of the decline would be one of the quickest on record. The ASX200 recorded a technical bear market (-20%) from its peak in just 14 days. The index didn’t stop there, falling 36% to its current low. The good news is that the index has since bounced back from this low by approximately 12%.
The cause of this market correction came from two primary sources. The first is obviously the novel coronavirus that emerged from China in late 2019 and quickly spread globally. Unlike the many Asian countries that learnt from the painful experience of SARS in 2002, Western nations are still learning how to deal with the situation that we are currently experiencing. The virus has forced many countries into shutdowns causing havoc to travel, hospitality and retail industries, all of which are all large employers.
The second factor was the collapse of the oil price. This shock to demand resulted from reduced air travel due to travel bans and a dispute between key OPEC members Saudi Arabia and Russia. OPEC, the Organisation of Petroleum Exporting Countries, couldn’t come to an agreement on production cuts resulting in Saudi Arabia ramping up their production and flooding supply into the market. While the oil price is historically very volatile and on its own and usually wouldn’t cause material economic turmoil, the market’s concern is with the nascent US shale oil market which carries high levels of debt and is uneconomic at the current oil price.
At times like this it is interesting to compare the current situation to the past in an effort to foresee how and when this situation will pass. This however is difficult to predict as the causes and policy responses are materially different to past events. It is unlike the Global Financial Crisis as the current damage to economic activity is much larger and more immediate and there is little governments or central banks can do to stimulate employment as people are physically unable to work.
Many people have also compared the current conditions to the Great Depression, but we believe that current policy responses has been much quicker and better targeted than what was possible in the 1930`s. It appears any economic recovery is not possible until the health crisis is resolved and the timing of this is difficult to predict. We are encouraged that the combined efforts of the world’s best scientists are working on tests, cures and vaccines, and the regulatory system is engaged in securing safe medicine to patients as soon as possible.
Unfortunately, the first trickle of data points on the coronavirus impacts have not been good. Singapore has been the first country to release their first quarter GDP, with the country’s output falling 2.2% from last year. Their economic forecast for the full year is a fall of between 1 to 4%. This is concerning because Singapore has had the most success in containing the coronavirus and has been able to keep businesses operating as normal.
Another concerning statistic is the extraordinary spike in US initial jobless claims. This is a weekly reading of people who apply for unemployment benefits in the US. Last week 3.3 million Americans lodged initial claims, vastly eclipsing the previous record of 695,000 in 1982. This week the number doubled to 6.6 million new claims. The flow on effect to unemployment will be substantial.
Turning to the Oracle portfolios, despite significant falls I am pleased to say that all four equity portfolios outperformed their respective benchmarks over the quarter and is a testament to our investment team for implementing the philosophy of Oracle Investment Management, which is a focus on quality businesses whose operations and balance sheet can withstand periods of severe stress.
Whilst we believe that owning the best businesses possible will outperform in good times, it is in the difficult times that the strategy really pays dividends as the market exits companies with high debt or those whose operations rely on a strong economy to succeed.
Though we constantly monitor our portfolios, we held multiple meetings late in the quarter to review the economic health of every business we own to stress test them for the worst case scenarios. As a team we emerged from this review confident in our portfolios and how they are positioned over the medium to long term. Our portfolios have minimal exposure to travel, hospitality or retail, and have been underweight the banks for several years. The banks find it harder to generate profits when interest rates are close to zero as it severely crimps their net interest margin.
Whilst no one can predict how long the current environment will last, we can confidently say that at some point we will emerge on the other side and markets will begin their relentless grind higher as they have many times before.
As active investment managers it is our role to ensure that we focus on quality businesses with strong balance sheets, which is more important than ever. This continues to be a core tenet of Oracle Investment Management.
As always, please feel free to speak to your advisor if you require advice during this turbulent market and to ensure you are comfortable with the risk exposures in your portfolio.