DIARY OF A FUND MANAGER - THE HEART OF THE MATTER- 10.02.20

Coronavirus ripples are spreading out from Wuhan bringing uncertainty to financial markets. This week’s Diary delves a bit deeper into the investment consequences of a genuine unknown.

For most of last week, markets in their collective wisdom seemed to have concluded that the impact of the coronavirus was understood and that the peak in the infection rate was just over the horizon. Accordingly, equities moved higher and safe haven bonds fell back. It was only late on Thursday and then throughout Friday that the news worsened and the rally subsided.

It is a strange time for those trying to analyse the future with any degree of accuracy. Although numbers describing the recent past are encouraging, they may have little to do with the future. For the record, the economic statistics designed to capture what went on in January have been in line or better than expectations, corporate profitability is holding up well, and job creation continues at a respectable rate. Governments and central banks have been active; we have seen tariff cuts, lower interest rates and, in China, ample liquidity pumped into the system. These days the authorities regard bolstering growth as the number one priority when an unexpected unknown appears. In the UK, the numbers were particularly encouraging as we embarked on our post-Brexit, pre-deal future outside the EU.
On the political front, voters from India to Ireland are having their say, whilst events in the US defy rational analysis. A failed app in the Democratic Iowa caucus has replaced the Florida hanging chad from a generation ago. Back in the UK, the approaching cabinet reshuffle may grab a few headlines, but is unlikely to have much impact on implementing what Boris wants in terms of policy priorities or the conduct of negotiations with the EU. Staying in Brussels, the first EU budget without the UK will be interesting. A weak German economy supporting the rest won’t read well in the Bundestag.
Financial analysts have been hard at work reducing forecasts for 2020 as the impact of the coronavirus spreads. Earnings forecasts throughout Asia are lower now than at the start of the year as are economic growth numbers globally. This isn’t just a reaction to uncertainty, but a rational response to an interruption to finely balanced global supply chains. Factories reliant on Chinese components are starting to feel the strain; not just locally but further afield too. Hyundai in South Korea has closed a production line and if this goes on much longer shortages could start to emerge in Europe. Alternatives exist, but take time to bring on stream.
In last week’s Diary I said that I would record the progress of the coronavirus and its impact on investment markets as a way of remembering what we thought we knew. Analysis of infection rates and fatalities seemed to be providing certainty allowing those who had ‘seen it all before’ to buy the dip.
What rattled confidence late in the week was the realisation that the numbers were higher than previously reported and that this has been going on for longer than we had been told. News, fake news and guesswork vied for attention. Reports from around the world have been mixed with industry more worried than consumers. Travellers are in the frontline as I heard from an exasperated Diary reader who arrived in San Francisco just after a flight from China. They waited four hours to clear immigration as all had their temperature taken. And from Beijing, travel advice to those able to get a flight is to arrive eight hours before departure.
At the heart of this broad mix of economics, business, politics and disease is the question that has been worrying investors for much of the last year. Are we in a mid-cycle economic slowdown or is the longstanding upswing that has been in place for over ten years finally coming to an end? Apart from the human impact, the coronavirus is also throwing grit into the wheels of commerce. How long this goes on for is starting to matter.
Discussing these issues and much else with a former number one rated equity analyst and now a serial non-executive director was illuminating. Towards the end of any economic cycle there is typically a crescendo of excess where hubris is exposed by the sheer weight of the inconsistencies presented as facts. Eventually emperors are found to have no clothes. Steadily over the last decade the importance of company analysts has been downgraded as passive investment strategies and factor-driven algorithms have become increasingly important. What has been forgotten is that companies can present numbers in various ways, some more creative than others. Judging the integrity of management teams requires contact and experience. Then the numbers need detailed analysis to sort out the wheat from the chaff. When the tide does eventually turn all will be revealed.

Written by

David Miller
Investment Director

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