Market meltdown

By Martin Fowler - March 23, 2020

A combination of the COVID-19 outbreak and sliding oil prices has seen the ASX200 on track for its worst quarterly performance in decades.

Read: Sydney Wealth Management Update Autumn 2020

The last significant quarterly decline was the December quarter of 2018 when the Total Return Index (the ASX200 adjusted for dividend payouts) declined by 9.0%. The decline thus far this quarter is around three times the worst quarterly declines suffered during the height of the GFC.

Impact on Portfolios

A drawdown is a peak-to-trough decline during a specific period for an index, investment, fund or portfolio. At the time of writing the ASX200 Total Return had declined 30% (i.e. suffered a drawdown of 30%) from the recent highs reached in February. The correction on the ASX has been relatively broad-based. Travel and tourism stocks, and stocks with exposure to Chinese demand (resources and transport related stocks such as Qantas to name a few) initially bore the brunt of the market’s sharp decline, though this has recently spread to banking stocks, infrastructure, property trusts as well as healthcare stocks.

If the rate of spread of COVID-19 outside China slows, it would be expected that the oil price, which has been hit by both a demand shock (COVID-19 related) and a supply shock, would rebound. The supply shock has been exacerbated by the Saudi Arabians and Russians not agreeing on a cut to production, which has subsequently seen the Saudis significantly increase production, sending the oil price into freefall.

Whilst investors are understandably concerned at large sell-offs in the market, the magnitude and timing of these events are usually very difficult to predict. Investors can take comfort if their portfolio contains quality companies, many of which exhibit several of the following characteristics:

  • competitive advantage or in an industry with high barriers to entry;
  • balance sheet strength;
  • solid cash flow generation; and
  • attractively to fairly-valued compared to mid-cycle benchmarks.

As we shall see in the next section, the significant drawdowns observed this century are eventually reversed. It is important to add the caveat that this analysis is a historical one and that future drawdowns may not exhibit the same characteristics as those observed between the years 2000 to 2020. For example, if Australia enters a recession, as is a distinct possibility, the economic environment will be far different to that seen from the turn of this century. Similarly, if the COVID-19 pandemic continues to worsen, the economic environment may continue to deteriorate, leading to further losses on the ASX.

Drawdown Analysis

Investors are understandably worried when markets fall heavily and many fundamentally sound companies are sold off indiscriminately. However, investors should take comfort that significant falls in the past have, over time, been reversed. The current falls have had their origins in the COVID-19 pandemic spreading from China to Europe. Whilst even epidemiologists and virologists have conflicting views on when the situation will eventually ease, the consensus is that it will ease. At that time, pent-up demand coupled with significant stimulus measures by many governments and central banks around the world are likely to provide a tailwind for equity markets.

The following analysis involves ASX200 Total Return data, obtained from Morningstar. The data goes back to 31 March 2000. We graph the data below:

Two of the notable outbreaks this century were:

  • The 2003-2004 Severe Acute Respiratory Syndrome (SARS) outbreak. SARS was first reported in Asia in March 2003[2]. During the period of infection, there were 8,098 reported cases of SARS and 774 deaths[3]
  • The 2009-2010 Swine flu pandemic. The Centers for Disease Control (CDC) estimated there were 60.8 million cases (range: 43.3-89.3 million), 274,304 hospitalisations (range: 195,086-402,719), and 12,469 deaths (range: 8,868-18,306) in the United States due to the (H1N1)pdm09 virus[4]

The SARS outbreak was first made public at a time when the ASX200 Total Return Index was already 20% below its recent peak (i.e. a level of drawdown of close to 20%). The impact on the index from the news and spread of SARS was minimal. The Total Return Index for the period 2002 to 2004 is shown below.

 
Even with the SARS news in the market, half of the 20% drawdown at the time was recovered within 150 trading days. The drawdowns for the Total Return Index for the period 2002 to 2004 are shown below.

The Swine flu pandemic occurred in 2009-2010. The pandemic coincided with the GFC, so the effect of the outbreak on the stockmarket is difficult to discern as the event was overwhelmed by the seismic global economic impacts at the time. The impacts of the GFC on the Australian stock market can be seen in the chart below, which shows the Total Return Index for the S&P/ASX200 during the period from 2008 to 2014.

During the GFC the ASX200 Total Return fell by approximately 50%. The effects of the swine flu on the market cannot be readily determined but were understood to have been minimal. It took approximately six months for half of the market losses to be recovered. The market subsequently reached a new high in September 2013. This is shown in the following graph.

There are many differences, both epidemiological and statistical, between the COVID-19 pandemic and the outbreaks of SARS and swine flu. Wilder-Smith, Chiew and Lee note that “although there are striking similarities between SARS and COVID-19, the differences in the virus characteristics will ultimately determine whether the same measures for SARS will also be successful for COVID-19. COVID-19 differs from SARS in terms of infectious period, transmissibility, clinical severity, and extent of community spread”[5]. From a market perspective, both previous outbreaks commenced when the market was down 20% and 50% respectively from recent highs. The COVID-19 outbreak coincided with markets being at record highs. We now plot the drawdowns from the past 20 years and examine the biggest drawdowns and the time taken for these to be erased.

From the above graph the most significant drawdowns and the time taken for these drawdowns to (1) be halved; and (2) be eradicated, are as follows:

Date

Drawdown

Days to recoup

50% of drawdown

Days to recoup

100% of drawdown

24 September 2001

15.5%

13 trading days

69 trading days

13 March 2003

19.6%

32 trading days

150 trading days

12 February 2016

17.6%

46 trading days

210 trading days

16 March 2020

29.5%

17 trading days
at time of writing

?

 

It is important to note that the current drawdown is 29.5% and may worsen in the extremely volatile current market.

Conclusion

The speed of the market correction over the past month has been virtually unprecedented. Even the 20% decline during the GFC took 55 days to reach. The current 30% decline has taken 17 days. This is an unnerving time to be an investor given the crisis has not yet peaked in most countries, so further sharemarket declines cannot be ruled out. However, once a bottom in the index is in place, a large part of the losses is likely to be recouped in a timely fashion.

Disclaimer
Liability limited by a scheme approved under Professional Standards Legislation. Any advice included in this newsletter has been prepared without taking into account your objectives, financial situations or needs. Before acting on the advice you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs. You should also obtain a copy of and consider the Product Disclosure Statement for any financial product mentioned before making any decisions. Past performance is not a reliable indicator of future performance. Advisors at Pitcher Partner Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth management Pty Ltd, ABN 85 135 817 766, AFS and Credit Licence number 336950.

[2] Centers for Disease Control and Prevention (https://www.cdc.gov/sars/about/fs-sars.html)
[3] National Health Service (https://www.nhs.uk/conditions/sars/)
[4] Centers for Disease Control and Prevention (https://www.cdc.gov/flu/pandemic-resources/2009-h1n1-pandemic.html)
[5] Can we contain the COVID-19 outbreak with the same measures as for SARS? Annelies Wilder-Smith, Calvin J Chiew, Vernon J Lee. Lancet. Infectious Diseases 2020 March 5.

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