B6 O THEGLOBEANDMAIL| WEDNESDAY,MARCH11,2020
LOBEI"9ESTOR
| REPORTONBUSINESSW
hen pandemic scare stories
dominate social media, and
stock markets ricochet from
panic to optimism, what
should a rational investor doÌ
Here are four helpful thoughts to
keep in mind. They can help maintain
your sanity as the latest news blows your
emotions one way or the other.
PANICSAREMORECOMMON
THANYOUTHINK
Surely you must remember the great
market crash of Oct. 27, 1997, when the
Dow Jones Industrial Average plummet-
ed 7 per cent because of panic over the
developing Asian financial crisisÌ
Probably not. As it turned out, North
American markets bounced back in
short order.
Such mini-panics are more common
than most people realize, according to
John Huber, who runs Saber Capital
Management LLC. Memories of many
downturns fade quickly, Mr. Huber
wrote in a note.
Even die-hard market followers may
have to think twice to recall the plunges
that accompanied the collapse of hedge
fund Long-Term Capital in 1998, the
SARS epidemic in 2003, the Flash Crash
in 2010, the U.S. debt-ceiling standoff of
2011 and the rising interest rates panic of
late 2018.
Few people remember any of these
mini-panics because they did not devel-
op into full-blown recessions. No one
knows how the current crisis will evolve.
But we should all take a deep breath and
remind ourselves that a bad patch in the
stock market does not necessarily por-
tend greater economic woes.
EXPECTAMIXEDDIETOFNEWS
There are huge unknowns around the
novel coronavirus outbreak. Investors
should respect those uncertainties.
However, they should also resist the
temptation to dwell only on the worst
possible cases.
Contrary to what you may think, good
news about the coronavirus is on the
rise, writes Eric Lascelles, chief econo-
mist at RBC Global Asset Management.
China, for instance, has made remarka-
ble progress in slowing the spread of the
disease. On Monday, it reported just 45
new cases in the country of 1.4 billion.
From all official indications, the Asian
giant has managed to control its virus
outbreak – granted, at big economic
cost.
Some skeptics doubt China’s num-
bers, but a similar trend appears to be
unfolding in South %orea. The outbreak
there “peaked at over 800 new cases per
day, but is now down to less than 400
daily and steadily falling,”
Mr. Lascelles says.FOCUSONTHELONGTERM
Bans on public gatherings,
school closings, shuttered
offices and a boom in tele-
commuting could all be
outcomes of the virus out-
break in North America.
These measures, if institut-
ed, will punch a hole in ec-
onomic output for as long as they last –
probably, not more than a month or so.
However, none of them will affect the
long-term ability of the economy to pro-
duce goods and services.
The virus’s long-run impact on gross
domestic product will be trifling in both
North America and around the world,
according to Morningstar researchers
%aren Anderson and Preston Caldwell.
They expect the virus outbreak to take a
1.5-per-cent toll on global economic out-
put in 2020, but foresee just a 0.2-per-
cent hit in following years, once the out-
break comes under control.
“Damage to productive capacity will
be small, plus economic confidence
should quickly return once the virus
subsides,” they wrote in a report pub-
lished Tuesday.THEREISNOOBVIOUSRIGHTMOVE
It is easy for pessimists to see the wild
ups and downs on Bay Street and Wall
Street as omens of a new financial crisis.
Unlike the 2008 crisis, however, the cur-
rent turmoil isn’t about exotic financial
products blowing up or obscure corners
of the financial markets grinding to a
halt.
Today’s chaos is about a clear and pre-
sent danger – a medical emergency of
unknown severity, but probably limited
in duration. That should make it at least
somewhat easier for policy makers and
financial markets to ad-
dress.
It should also make it
easier for investors to
gauge. Aswath Damoda-
ran, a professor at New
York University and an ex-
pert on valuation, has a
helpful spreadsheet on his
website, Musings on Mar-
kets, which lets readers
play with various assump-
tions and see how they af-
fect the fair value of the SPP 500.
Prof. Damodaran’s own baseline as-
sumptions start with a virus-induced 10-
per-cent drop in corporate earnings this
year – a figure roughly in line with what
has occurred in many past U.S. reces-
sions. He then assumes half of this year’s
decline will be made up in subsequent
years as the economy bounces back to
normalcy.
Based on that, he figures the SPP 500
should be trading at 2,889 today – quite
close to the 2,880 level where it stood at
the end of trading Tuesday.
In a broader sense, his spreadsheet
suggests today’s market is neither a
screaming bargain nor irrationally ex-
pensive. Rather than betting big on ei-
ther outcome, investors may want to
ponder the benefits of doing nothing.Fourwaystostaycalm
during·andemic·anic
There’sprecedentfordealing
withepidemicanxiety–
thesetipscanhelpweather
theCOVID-19marketsways
ANewYorkStockExchangetraderpassesahand-sanitizingstationonTuesday.Two
Morningstarresearcherssaythenovelcoronavirus’slong-termimpactonGDPwillbe
triflinginbothNorthAmericaandaroundtheglobe.RICHARD DREW/ASSOCIATED PRESSWe should all take
a deep breath and
remind ourselves
that a bad patch in
the stock market
does not necessarily
portend greater
economic woes.IAN
McGUGAN
OPINIONINSIDE THE MARKET
T
he free-falling price of crude oil
has walloped North American
energy companies, and the Can-
adian banks that lend to them
are being hit almost as hard. But the
bank sell-off may be overdone, offering
a good buying opportunity – and divi-
dend yields that now average 5.7 per
cent.
In what is essentially a rerun of the
2014-16 oil price collapse, analysts are
now picking through the loan books of
the Big Six banks to determine their ex-
posure to energy companies and esti-
mating the downside risk to bank profits
if some of these energy loans go bad.
On Monday, the price of West Texas
Intermediate oil fell about 25 per cent,
for its worst one-day plunge in about
three decades.
It rebounded around 11 per cent on
Tuesday, to US$34.36 a barrel. But the
price remains well below US$60 a barrel
at the start of the year, and still threatens
the ability of some energy companies to
service their debts.
“We estimate that stressed loss rates
in oil and gas portfolios would reduce
[bank] sector earnings per share by 2 to
6 per cent,” National Bank Financial
analyst Gabriel Dechaine said in a note,
using the prior oil downturn as a tem-
plate.
“However, with [bank] stocks trading
down about 12 per cent [on Monday],
the market is clearly pricing in addition-
al downside,” he added.
Concerns about the financial health
of energy loans are raised at a time when
investors are already nervous about how
the banks will navigate through deterio-
rating global economic activity and fall-
ing interest rates amid the spread of the
novel coronavirus.
The good newsh The Big Six exposure
to the North American oil and gas sector
has fallen to about 2 per cent of their
overall loans from more than 5 per cent
prior to 2014.
The bad newsh In dollar terms, total
exposure is a massive $60-billion, ac-
cording to analysts.
Mr. Dechaine at National Bank ranked
the Big Six based on oil and gas loans as a
percentage of their total loans.
Four banks are clustered together.
Bank of Montrealis the most exposed
by a slim margin, with oil and gas loans
accounting for 2.8 per cent of its total.
Bank of Nova ScotiaandNational Bank
of Canadaare close behind, with 2.7-per-
cent exposure each.Canadian Imperial
Bank of Commercehas an exposure of
2.3 per cent.
The biggest banks, though, have less
exposure relative to their gargantuan
loan books.Toronto-Dominion Bank’s
loans to the oil and gas sector account
for just 1.3 per cent of its total loans, fol-
lowed byRoyal Bank of Canadaat 1.2
per cent.
The geographic breakdown is split al-
most evenly between the United States
and Canada for all but one bankh Nation-
al Bank’s energy loans are confined to
Canada.
Mr. Dechaine further examined the
loan books by breaking down the banks’
exposure to two higher-risk types of bor-
rowersh exploration and production
companies, whose revenue streams are
largely tied to commodity prices, and oil
and gas services firms, whose business
models depend on their EPP customers.
Based on this measure, RBC is the
most exposed. Its EPP and services
loans account for 89 per cent of the
bank’s oil and gas loans. BMO is next,
with an exposure of 73 per cent. National
Bank’s exposure is 60 per cent, followed
by TD at 57 per cent, CIBC at 51 per cent
and lastly Scotiabank at 50 per cent.
Mr. Dechaine said that the banks’ en-
ergy loan books are already reflecting
deteriorating credit metricsh The ratio of
impaired oil and gas loans recently
stood at 1.84 per cent for the Big Six, on
average. That’s well above the sector-
wide average loan loss ratio of just 0.53
per cent.
But the sell-off of bank stocks looks
worse than the backdrop – and this is
where the buying opportunity comes in.
Mr. Dechaine said that current valua-
tions imply an ugly environment for the
Big Six, including 2020 profits falling 14
per cent shy of his already lacklustre es-
timates and dividend increases put on
hold.
“To state the obvious, this figure is
much more than what we estimate in
terms of the EPS impact of a repeat of the
2015-16 oil and gas downturn,” he said.
After that downturn ended in early
2016, bank stocks rallied an average of
more than 40 per cent within 12 months.
And yes, those dividends continued to
increase.Whynowisa
goodo··ortunity
toloadu·
on
anadian
bankstocks
DAVID
BERMANOPINIONINSIDE THE MARKETI
nvestors hit the panic button on
Monday and the result looked like a
rerun of September, 2008.
The Dow suffered its worst one-
day point loss in history. It plunged 2,013
points, taking it back to levels last seen
in December, 2018. The SPPàTSX Com-
posite lost 1,660 points and was off al-
most 15 per cent for the year when the
closing bell mercifully sounded on Mon-
day.
Investors were already spooked by
the human and economic effects of the
novel coronavirus and resulting CO-
VID-19 disease. Then Saudi Arabia and
Russia decided on the weekend to play
their own game of beggar-thy-neigh-
bour, sending oil prices plummeting and
driving down the shares of energy com-
panies.
We have not seen this kind of volatil-
ity in more than a decade. At one point
on Monday, the CBOE Volatility Index
touched 62.12, its highest mark since the
financial crisis of 2008.
We saw a modest rally on Tuesday
morning. Don’t read too much into it. We
should expect more gut-wrenching vola-
tility in the future. There are more diffi-
cult days ahead for investors.
It’s impossible to predict the future in
this turbulent environment, but here’s
what I expect to happen.
THINGSWILLGETWORSE
BEFORETHEYGETBETTER
The Bank of Canada said as much in an-
nouncing a half-point rate cut last week.
“COVID-19 represents a significant
health threat,” the bank said. “It is likely
that as the virus spreads, business and
consumer confidence will deteriorate,
further depressing activity.”THENUMBEROFCONFIRMEDCASESWILL
GROWEXPONENTIALLY
Last week, I asked a Florida doctor who
runs a large medical clinic what she
would do if someone walked in display-
ing COVID-19 symptoms. “I’d have to
send them elsewhere,” she said. “We
have not received any test kits for the vi-
rus.”
That comment speaks to the state of
unpreparedness in the United States and
suggests the number of infected people
in the country may be far higher than re-
ported. Washington State, for example,
now says the virus was circulating there
for weeks before it was finally detected.
U.S. Vice-President Mike Pence, who
is co-ordinating the Trump administra-
tion’s task force on virus response, ad-
mitted that while more test kits are be-
ing distributed, they are still in short
supply. Meanwhile, the guidelines of
who should be tested have been broad-
ened. The end result, once more kits are
available in the coming weeks, will prob-
ably be a big spike upward in the num-
ber of confirmed cases.INTERESTRATESWILLGOLOWER
The half-point drops in the U.S. and Can-
ada last week were greater than expect-
ed, but may just be the beginning. If
health and economic conditions wors-
en, we could see rates back at 2008-09
levels before year-end. “As the situation
evolves, [the Bankof Canada’s]govern-
ing council stands ready to adjust mone-
tary policy further if required to support
economic growth and keep inflation on
target,” the bank said.
That could conceivably mean that the
negative interest rates we’ve seen in Eu-
rope and Japan could take hold here. “As
it scrambles to protect the U.S. economy
from the far-reaching fallout of the coro-
navirus, it can be expected that it [theFederal Reserve Board] could take rates
back down to zero – emergency territory- in the next few months,” said Nigel
Green, chief executive of deVere Group,
one of the world’s largest independent
financial-advisory organizations.
“This then raises the spectre that the
Fed will ultimately follow its peers in Eu-
rope and Japan by adopting negative in-
terest rates.”
The result, he says, would be to push
up the prices of financial assets, includ-
ing equities.
BONDPRICESWILLRISE
As yields fall, bond prices rise. As of the
close on Monday, the FTSE Canada Uni-
verse Bond Index was up 7.47 per cent
for the year, well ahead of the TSX,
which was down 14.94 per cent. That’s a
differential of 22.41 percentage points.INTEREST-SENSITIVESTOCKS
WILLHOLDUPBETTER
As rates continue to fall, interest-sensi-
tive equities will perform better than the
broad market, a continuation of what
we saw in 2019. As of March 9, the SPPà
TSX Capped Utilities Index was up 0.93
per cent so far in 2020. That’s not a big
gain, but it looks a lot better than the
Composite. The Capped REIT Index was
down 1.73 per cent – again, much better
than the broad market.GOLDREMAINSAHAVEN
The price of gold moves steadily higher
as virus concerns increase. As of Tuesday
afternoon, it was down for the day, trad-
ing under US$1,650 an ounce. But it’s up
about 8 per cent for the year and will
probably go higher if the coronavirus
crisis intensifies.
The take-away is that we are going to
have to live with uncertainty and vola-
tility for many months. Make sure your
portfolio is weighted toward bonds,
cash, gold and defensive, dividend-pay-
ing securities – and hang on.-re·areyour·ortfolioforthevolatilityahead
GORDONPAPE
OPINIONINSIDE THE MARKET
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