Please find this week’s edition of Weekly Digest attached.
Last week was a volatile one and this week looks like it will be more so. Over the weekend, Saudi Arabia walked away from the OPEC meeting in Vienna, unleashing an all-out price war with Russia. At the time of writing, the Brent crude oil price has fallen 20%. This has thrown markets, already deeply unsettled by Coronavirus, into turmoil.
Although consumers will welcome lower energy prices, the issue for stock markets is the double deflationary shock that is now unleashed. A global recession over the next three months already looked a real possibility, driven by a shortfall in demand as a result of coronavirus restrictions. Taken together, however, the impact of the lower oil price and the coronavirus is material and an economic recession in the first half of this year now looks likely.
Assuming that OPEC can patch up its differences and that the coronavirus is a seasonal spectre, the effects are likely to be transitory. We believe that ETFs (tracker funds) are acting as a magnifier of volatility and ultimately we expect markets to look through these events. The global financial system is well capitalised and, to the extent that these external events cause any stress, it is likely that banks will be supported by central banks so that they do not pass on any pain to businesses. We expect that governments will act to offset the economic pain that coronavirus restriction measures will impose. Borrowing at less than 1% for 30 years makes a great deal of sense at this time and we expect governments to accelerate their pro-cyclical fiscal agendas (an interesting Economist article on this subject re. the UK this week). Indeed, in Hong Kong, all citizens received a government cheque to compensate for lost earnings.
Equity prices are now factoring in a very poor outlook. Our preferred measure of value is a Dividend Discount model and, using the US as a proxy, this now suggests developed market equities are around 33% undervalued (versus c. 15% at the beginning of last week):
Overall, our strategy should be to look for an opportunity to buy risk markets, but we remain disinclined to get ahead of the newsflow on coronavirus. It is likely that patient, long-term investors will look back on this period in twelve months having benefitted from their resilience. We will look to take gradual steps.
Looking to the week ahead, Wednesday sees the release of the UK budget and Thursday sees a meeting of the European Central Bank.