FULL REPORT
Stock markets around the world suffered their worst performance since 1987. On the worst day US stocks were down 8% after which circuit breakers were deployed in order to pause trading. The FTSE 100 was down 7.7%. Government bond yields found new floors, with some in negative territory.
Central Banks stepped in to limit the economic impact of Covid-19, providing some temporary relief to investors. But investors are now increasingly becoming nervous that the Central Banks may have used up all their ammunition.
The Bank of England cut interest rates by 15bps, to 0.10% and announced additional QE of GBP200bn last week. This would take the total stock of asset purchases to GBP645bn. BoE have said that further asset purchases will take place as and when it is operationally possible.
Governments globally are now issuing targeted fiscal measures to help businesses avoid bankruptcy and support vulnerable people. The UK's Chancellor Sunak recently announced £350bn aid for UK businesses in addition to the pledge of £30bn outlined at the Budget.
The UK Purchasing Managers Index survey (PMIs) showed a huge drop in March with the composite Index falling to 37.1. The service sector was the hardest hit, falling from 53.2 to 35.7. This is the biggest monthly fall on record and an all-time low. The manufacturing index came in better than expected, dropping only by three points to 48.0.
According to the latest PMIs a q-o-q fall of 1.5-2% in UK's GDP is expected for the first quarter. With the lockdown only just being enforced, we do expect a worsening in the second quarter.
How does this compare with the global financial crisis? UK GDP contracted by -2.1% in Q4 2008. Currently, we expect almost twice as much of a contraction in Q2. We do expect the UK economy to recover in second half of the year, therefore the recession is likely to be short-lived.
However, this will be based on the virus being under control by the summer and the measures announced by the BoE and the UK government are enough to prevent widespread bankruptcies and redundancies.
Summarising the events of the last month is difficult, but it is fair to say “Boris bounce” in sentiment and business investment that early-2020 surveys had pointed to has been well and truly extinguished. The UK is now facing a sharp recession.
The far-reaching stimulus package announced by the UK government has been generally welcomed, but landlords and tenants still have to make very difficult decisions to try to safeguard their futures, and uncertainty remains over the shape and timescale of any recovery.
The massive government response will help stave off some tenant business failures, but there remains deep uncertainty over real estate pricing as investors struggle to adequately price in risk. Eleven funds, holding a total of almost £15 billion, have suspended trading due to “material uncertainty” in their asset valuations. On 18th March, UK REITs were trading at a 39% discount to NAV, and the average share price was 35% down on the start of the year before recovering slightly last week. More volatility is expected as market data showing the true impact of social distancing on leasing and footfall is released.
However, the listed sector's distress may tempt many investors to acquire stakes in those well-managed REITs that focus on resilient sectors, such as logistics, supermarkets and healthcare. Given direct real estate's current liquidity issues, this could be an efficient way of buying into some prime markets at a discount. Moreover, as institutions and REITs step back from deploying capital, private equity investors with significant dry powder will see this crisis as a buying opportunity. Raising capital quickly will be key however, as will the ability to move without recourse to debt.
The pandemic is also highlighting some of the market's key trends, such as the lack of supply of retirement and social care homes. The growth of this sector should accelerate once the recovery begins. E-commerce will continue to take market share at the expense of the high street, bolstering the need for warehouse space while further encouraging retail's long-term correction.
This slowdown will be painful for many, but for those that can move quickly, this could be a buying opportunity.