Special announcement: COVID-19
Market update 9 – Half-time for markets.
L, U or V for recovery?
NZ Funds’ active management approach means clients’ growth portfolios have performed better than the share market. We have achieved this in two ways. Firstly, we have mitigated the downside. This means client portfolios fell less than the market selloff. Second, we have fully participated in the market rebound capturing more returns than the market as it bounced back.
It is now half-time for global share markets. Markets are halfway between the high set prior to the onset of COVID-19 and the low of March 2020 when the reality of the pandemic took hold, but governments were yet to respond. As in sport, half-time gives the market time to digest what has just happened. In this case, what are the health and economic impacts of COVID-19?
The economic recovery will take time. Countries, such as Italy which had little time to respond, are reeling from the medical and now economic horrors of the virus. They will react differently from countries such as New Zealand and Australia, which have been fortunate enough to respond quickly but which are likely on the verge of an economic recession.
The shape of possible recoveries
The first step in any economic recovery is for output to stop shrinking. But the more interesting question is what shape the recovery will take.
The debate centres around three scenarios: ‘V’, ‘U’ or ‘L’ . A V-shaped recovery would be vigorous, as pent-up demand is unleashed. A U-shaped one would be feebler and flatter. In an L-shaped recovery, growth would not return for some time.
L-shaped recovery
The L-shape is the most pessimistic outlook, which shows sustained weakness and more permanent damage from the COVID-19 induced lockdowns. Unemployment stays high, and output does not fully rebound for several years.
In this scenario we may retest the share market lows seen in March with a lower chance of an immediate bounce back. However, we put little weight on a 1930’s style great depression given the myriad of initiatives implemented by New Zealand and other governments including Australia, United States and China.
Unprecedented levels of government support have been implemented in less than 100 days compared to what took place in the 1930s. With no central bank and high public debt, the New Zealand government did little in the way of propping up the economy in the 1930s. In fact, interest rates remained stubbornly high.
U-shaped recovery
In the U-shaped recovery, the pickup in activity happens gradually. The second half 2020 rebound does not make up for the steep decline in the first half of this year. It may be predicated on some delay in fully reopening the economy.
In this scenario, the share market may trade in a range of ±20% over the next one to two years, as business and economies join with governments and centrals banks to implement a recovery.
V-shaped recovery
The V-shaped recovery represents the most bullish outlook. The economy was on a solid footing before the COVID-19 shutdown, and a V-shaped rebound would consist of a rapid return to the same level of output once social distancing restrictions are removed. Growth in the second half of 2020 would make up much of the shortfall of the first half.
Because of the size and power of government stimulus and support, the scales are tipped in favour of financial assets continuing their move higher. Over the month of April, markets have recovered even as the ‘real’ economy works through the damage caused by COVID-19.
Some industries and sectors will take longer to recover but it does not mean they will necessary be left to collapse. The rapid rescue of Air New Zealand and Deutsche Lufthansa by their respective governments are but two examples.
Which shape is it?
We do not have a strong opinion which shape triumphs from here. Put differently, clients’ investment portfolios and KiwiSaver are set up to add value under all shapes.
We do have a strong opinion on the ability of financial markets to recover faster than the ‘real’ economy. Therefore, no matter the shape, those with a medium- to long-term horizon should remain invested. Remaining invested in financial assets for the long term provides an incredible opportunity to build wealth.
Financial assets can rise in value even as the economy is busy repairing itself. Share markets are forward-looking, reflecting expectations of where the underlying businesses that make up the share market will be in three to five years (not months!) time. At the same time, governments and central banks are effectively protecting the financial system. They are being more aggressive and proactive than in any other time in modern history.
Portfolio positioning
Should we have an L-shaped recovery, our goal is to mitigate the downside. NZ Funds is well prepared for this scenario and we will be able to act aggressively in preserving clients’ capital. In this scenario we would expect the economy to not be responding to government stimulus. However, clients’ portfolios will not be devoid of returns. Rather, different asset classes, such as gold, are likely to generate significant capital gains.
Should we have a U-shaped recovery we expect there will be times where we must mitigate a further share market sell off. At the same time, recognising the ability of financial markets to recover faster than the economy, we aim to become fully invested as the market bounces. Clients will also benefit from different asset classes as the market turns.
Should we have a V-shaped recovery, our aim is to continue to benefit from a rising market. In this scenario we would expect clients’ portfolios to rise rapidly and we are positioned to harness this should it occur. Yet we retain our ability to mitigate the downside if we are wrong.
As we reflect on three possible paths forward, NZ Funds’ clients are likely to be better off remaining invested rather than trying to time markets. Even in the most negative L-shaped scenario, leaping into cash may mean a meaningful destruction in spending power and wealth as price inflation of goods and services outweigh any return generated in cash and term deposits.
As the famous investor Peter Lynch once said, “far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves”. Volatility has decreased allowing those with money to invest to build up their savings at an attractive and stable entry point. When markets restart their upward climb, those with long-term time horizons will benefit from a share market that will be substantially higher over the next one, three and five years.
It is now half-time for global share markets. Markets are halfway between the high set prior to the onset of COVID-19 and the low of March 2020 when the reality of the pandemic took hold, but governments were yet to respond. As in sport, half-time gives the market time to digest what has just happened. In this case, what are the health and economic impacts of COVID-19?
The economic recovery will take time. Countries, such as Italy which had little time to respond, are reeling from the medical and now economic horrors of the virus. They will react differently from countries such as New Zealand and Australia, which have been fortunate enough to respond quickly but which are likely on the verge of an economic recession.
The shape of possible recoveries
The first step in any economic recovery is for output to stop shrinking. But the more interesting question is what shape the recovery will take.
The debate centres around three scenarios: ‘V’, ‘U’ or ‘L’ . A V-shaped recovery would be vigorous, as pent-up demand is unleashed. A U-shaped one would be feebler and flatter. In an L-shaped recovery, growth would not return for some time.
L-shaped recovery
The L-shape is the most pessimistic outlook, which shows sustained weakness and more permanent damage from the COVID-19 induced lockdowns. Unemployment stays high, and output does not fully rebound for several years.
In this scenario we may retest the share market lows seen in March with a lower chance of an immediate bounce back. However, we put little weight on a 1930’s style great depression given the myriad of initiatives implemented by New Zealand and other governments including Australia, United States and China.
Unprecedented levels of government support have been implemented in less than 100 days compared to what took place in the 1930s. With no central bank and high public debt, the New Zealand government did little in the way of propping up the economy in the 1930s. In fact, interest rates remained stubbornly high.
U-shaped recovery
In the U-shaped recovery, the pickup in activity happens gradually. The second half 2020 rebound does not make up for the steep decline in the first half of this year. It may be predicated on some delay in fully reopening the economy.
In this scenario, the share market may trade in a range of ±20% over the next one to two years, as business and economies join with governments and centrals banks to implement a recovery.
V-shaped recovery
The V-shaped recovery represents the most bullish outlook. The economy was on a solid footing before the COVID-19 shutdown, and a V-shaped rebound would consist of a rapid return to the same level of output once social distancing restrictions are removed. Growth in the second half of 2020 would make up much of the shortfall of the first half.
Because of the size and power of government stimulus and support, the scales are tipped in favour of financial assets continuing their move higher. Over the month of April, markets have recovered even as the ‘real’ economy works through the damage caused by COVID-19.
Some industries and sectors will take longer to recover but it does not mean they will necessary be left to collapse. The rapid rescue of Air New Zealand and Deutsche Lufthansa by their respective governments are but two examples.
Which shape is it?
We do not have a strong opinion which shape triumphs from here. Put differently, clients’ investment portfolios and KiwiSaver are set up to add value under all shapes.
We do have a strong opinion on the ability of financial markets to recover faster than the ‘real’ economy. Therefore, no matter the shape, those with a medium- to long-term horizon should remain invested. Remaining invested in financial assets for the long term provides an incredible opportunity to build wealth.
Financial assets can rise in value even as the economy is busy repairing itself. Share markets are forward-looking, reflecting expectations of where the underlying businesses that make up the share market will be in three to five years (not months!) time. At the same time, governments and central banks are effectively protecting the financial system. They are being more aggressive and proactive than in any other time in modern history.
Portfolio positioning
Should we have an L-shaped recovery, our goal is to mitigate the downside. NZ Funds is well prepared for this scenario and we will be able to act aggressively in preserving clients’ capital. In this scenario we would expect the economy to not be responding to government stimulus. However, clients’ portfolios will not be devoid of returns. Rather, different asset classes, such as gold, are likely to generate significant capital gains.
Should we have a U-shaped recovery we expect there will be times where we must mitigate a further share market sell off. At the same time, recognising the ability of financial markets to recover faster than the economy, we aim to become fully invested as the market bounces. Clients will also benefit from different asset classes as the market turns.
Should we have a V-shaped recovery, our aim is to continue to benefit from a rising market. In this scenario we would expect clients’ portfolios to rise rapidly and we are positioned to harness this should it occur. Yet we retain our ability to mitigate the downside if we are wrong.
As we reflect on three possible paths forward, NZ Funds’ clients are likely to be better off remaining invested rather than trying to time markets. Even in the most negative L-shaped scenario, leaping into cash may mean a meaningful destruction in spending power and wealth as price inflation of goods and services outweigh any return generated in cash and term deposits.
As the famous investor Peter Lynch once said, “far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves”. Volatility has decreased allowing those with money to invest to build up their savings at an attractive and stable entry point. When markets restart their upward climb, those with long-term time horizons will benefit from a share market that will be substantially higher over the next one, three and five years.
Source: Bureau of Economic Analysis, Haver Analytics, J.P. Morgan Private Bank Economics. Data and scenarios are as of April 13, 2020..
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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James Grigor is Chief Investment Officer for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. James' comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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