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Liquidity to companies, not capital markets, needed

Asia Analytica
Asia Analytica • 8 min read
Liquidity to companies, not capital markets, needed
The sell-off has been fast and furious. There is indiscriminate selling across the board, regardless of quality, likely perpetuated by algorithm trading and exchange-traded funds.
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Please note that starting this week, Tong Kooi Ong has temporarily ceased writing this column or make any contribution. This function is now taken over by Asia Analytica.

SINGAPORE (Mar 20): The sharp escalation of the Covid-19 outbreak continues to dominate headlines, raising anxiety and buffeting consumer and investor confidence the world over. The sell-off has been fast and furious. There is indiscriminate selling across the board, regardless of quality, likely perpetuated by algorithm trading and exchange-traded funds. Without better information of how long the outbreak will last, it is impossible to determine the economic fallout and, therefore, prescribe rational valuations to stocks.

The Volatility Index, often called the “fear” gauge on Wall Street, surged sharply higher, beyond even the peak during the global financial crisis (GFC) (see Chart 1). The heightened uncertainties and anxiety are also reflected in the huge daily point swings for the Dow Jones Industrial Average, the most closely watched bellwether index in the financial world (see Chart 2). Even Treasury bonds and gold — traditional safe haven assets — have come under heavy selling pressure in recent days (see Chart 3).

The synchronised selldown suggests that investors are now rushing to cash above all asset classes. Yet others may be liquidating to cover stock losses. The world that was awash with liquidity is now seeing a credit crunch, especially among those already overleveraged.

Most governments remain focused on containment as the primary response — ordering travel bans, stopping mass gatherings, closing schools, shuttering storefronts and urging employees to work from home where possible and, in extreme cases, carrying out full lockdown of cities and entire countries. There will be significant economic damage in the short term as the world comes near a standstill.

Despite these drastic measures, it may be inevitable that a good percentage of the world’s population will eventually be infected. We are confident that a treatment and/or vaccine will be developed, sooner rather than later, given the urgency of the situation. And those that recover — the fatality rate is running at 2% to 3% — would contribute and build herd immunity, the way humans have adapted to all viruses for thousands for years.

Till then, central banks and governments are doing everything they can to minimise the impact. On March 15, the US Federal Reserve threw everything it had, including the proverbial kitchen sink, at the viral outbreak. The central bank slashed the federal funds rate by a full percentage point to near zero and launched a massive US$700 billion (RM3.08 trillion) quantitative easing programme. The purchase of Treasury and mortgage-backed securities will boost liquidity and ensure the credit market continues to function.

The Fed also cut the rate of emergency lending at the discount window for banks by 125 basis points to 0.25%, and lengthened the term of loans from overnight to 90 days. These measures are similar to those implemented during the Great Recession.

Nevertheless, there are fundamental limitations to the efficacy of monetary policy in this kind of crisis. When worry turns to fear, which then turns to panic, the capital market becomes dysfunctional. Simply injecting liquidity into the market becomes ineffective. The money needs to reach companies, including smaller and lower-quality ones.

On March 17, the Fed further announced the establishment of a Primary Dealer Credit Facility to 24 large financial institutions. The PDCF will offer overnight and term funding with maturities up to 90 days, collateralised by a broad range of investment-grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities. The Fed is also buying commercial papers directly from companies unable to get short-term credit, under the Commercial Paper Funding Facility.

These are also GFC-era measures, to head off the emerging liquidity crunch and ensure the availability of credit to businesses and households. This is also where fiscal stimulus will be most effective, in terms of direct aid. Fortunately, governments have been relatively quick in offering financial help to businesses — such as targeted loans and tax cuts, especially for hard-hit industries and small and medium enterprises — as well as cash handouts to the people.

At the point of writing, US President Donald Trump is pushing to pass a fiscal package for up to US$1 trillion plus US$300 billion in delayed tax payments. We are hopeful that with the help of both fiscal and monetary stimulus, governments will be able to tide businesses through these difficult times, protect against job losses and provide a boost to the recovery process after the peak of the outbreak.

Adobe

Last week, we assessed the impact on US software companies, owing to the widening spread of Covid-19. We believe the immediate earnings hit will be comparatively limited, especially where the bulk of revenue is derived from subscriptions that do not require physical sell-through or are not hindered by mobility restrictions.

Adobe released its earnings results for the quarter ended February (1QFY2020) on March 12. Revenue was up 19% year on year to US$3.09 billion, ahead of market expectations. But, more importantly, the company is among the first software-as-aservice (SaaS) companies to offer additional insight into the impact of the viral outbreak.

“Our recurring revenue model and the real-time visibility we have into our business uniquely positions Adobe to manage through an uncertain environment,” it said. The company also warned, however, that future revenue would be negatively affected if customers delayed booking decisions and consulting services, and reduced marketing spending; consumers reduced spending; and software licence revenue driven by channel partners fell.

The company estimates revenue growth for the Digital Media and Digital Experience segments at 19% and 12% respectively for the current quarter, about 3% lower than that reported in 1QFY2020. Total revenue is estimated at US$3.175 billion for 2QFY2020. Adobe’s guidance reaffirms our initial impact assessment for a typical SaaS company.

The Walt Disney Co

We disposed of our remaining shares in Disney at a loss. We remain confident in the company’s long-term outlook but its near-term earnings will be significantly hurt by the outbreak.

The company has had to temporarily close all six of its theme park resorts around the world as well as its cruise line business. Retail sales for the consumer products (toys) segment will suffer as stores and malls shutter.

In addition, the studio business will be severely affected, with theatres closed and people avoiding small, crowded enclosed spaces. The company has postponed some new releases, including expected blockbusters, Mulan and Black Widow, and halted production for several live action films. These moves will have a cascading impact on future releases as On the other hand, its streaming business, Disney+, should benefit, as it is one of the few means of entertainment for people staying home. The service is set for launch in the UK, Ireland, France, Germany, Italy, Spain, Austria, Switzerland and India later this month. But the additional revenue would not make up for shortfalls from the other businesses.

The Boeing Co

Shares in Boeing were among the worst hit in the sell-off. The entire aviation sector is under severe pressure, with travel bans in effect around the world.

Airlines are struggling to manage their cash flow amid sharp cutbacks in flights and load factor. Some will be forced to defer the delivery of aircraft and delay or even cancel new orders. We do not expect a permanent decline in future air travel demand, but the current cash flow strain will make short-term business conditions extremely tough.

The outbreak is a double whammy for Boeing, compounding problems from its grounded 737 MAX planes. It previously announced a hiring and overtime freeze to preserve cash. As the crisis worsens, however, the company is seeking short-term financial assistance from the government. In a positive move, Trump has vowed support for Boeing, expected to be in the form of loan guarantees for up to US$60 billion, and aid to the airlines could top US$50 billion.

The Global Portfolio suffered another steep loss for the week ended March 19, losing 17%, mirroring the broader market decline. Lennar, Builders FirstSource and Boeing registered huge losses for the week, down between 42% and 46% for the week.

Last week’s losses sent the Global Portfolio deep into negative territory. Total portfolio value is now down 16% since inception. By comparison, the benchmark MSCI World Net Return Index is down 16.6% over the same period.

The Global Portfolio remains near fully invested, with just 6.2% in cash. We will hunker down and wait out this crisis.

Tong Kooi Ong is the chairman of The Edge Media Group, which owns The Edge Singapore.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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