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How does the Coronavirus crash compare to the GFC?

The Coronavirus pandemic is escalating by the day. We take a look at how it compares to the GFC and take some learnings from the GFC to apply to the Coronavirus crisis

By ETF Watch - Mar 15, 2020

It’s been a memorable few weeks for humanity. The Coronavirus pandemic is escalating by the day, with preventative health measures put in place not seen at least by the Western World in most of our lifetimes. Share markets has behaved as expected, with large falls and wild swings, as the pandemic unfolds.

Right now the Australian share market is down around 25% off its high, and saw the largest one day swing since 1987 on Friday the 13th of March. Nobody knows where the bottom is but if there’s one thing that is almost guaranteed, it is that volatility will persist for a while yet.

So how does the Coronavirus crash compare to the GFC?

For many investors who have entered the market over the last 10 years, this will be the first share market crash they have experienced. For others this will bring back memories of 2008 and 2000, and for those with a few more grey hairs, 1987.

Today we’re going to take a look at how the crash has played out so far compared to the GFC crash of 2008 and take a look at what might be in store.

Of course these two crisis’ could not be more different. The GFC was a bank driven crisis, with the current crash a health drive crisis. However, the end result from an economic perspective is likely to be similar, with a reduction in economic activity and a global recession to follow.

Whilst the ETF market in Australia contains over 200 funds now and $60 odd Billion in funds, it was a fledgling industry back in the pre GFC days. In December 2007 when the GFC really began, there were only 19 ETFs available, for a total of $1.5 Billion. Most investors had not even heard of ETFs.

The biggest Australian ETF at the time (and until last year, continued to be Australia’s biggest ETF) was the SPDR S&P/ASX 200 Fund (STW). This was Australia’s first ETF and tracks the benchmark S&P/ASX 200 Index. We’ll use the performance of STW to compare the GFC to the Coronavirus crash.

For the purpose of the analysis we’re using 11 December 2007 as the start of the GFC. The first murmurs of the sub-prime lending issue were earlier in 2007, but it was 11 December that markets hit their high. For the latest Coronavirus crash, markets peaked on 20 February 2020, so that’s the start date, and we are now 17 days in.

The below chart shows the first 17 days of each crisis.

It can be seen that whilst the first week or so followed a similar path, the falls in the Coronavirus crisis have been much more rapid than the GFC. This doesn’t tell the full story however, with the GFC falls beginning in mid December, they paused over the Christmas period before gaining speed in January 2008.

Below we show the full extent of the GFC crash. It took just over 300 trading days or 16 months to fully play out, with the recovery commencing in March 2009. The peak to trough falls were almost 50% (the chart has been adjusted for the reinvestment of dividends, without including dividends the fall was over 50%).

Looking at a longer time scale, the initial days of both crashes look remarkably similar, with the Coronavirus driven falls being a little more violent than the early GFC falls. It actually took about 140 days for the GFC falls to reach the levels that Coronavirus reached in just 16 days.

Whilst the speed of these recent falls compared to the GFC may concern some people, each crisis played out much differently. Due to the complexity of the financial system and the instruments (Sub Prime CDOs) that triggered the GFC, it took time for markets to disseminate the information. The GFC was a drawn out event that took many months to play out. Coronavirus on the other hand is playing out incredibly quickly, with key information such as number of cases and border lockdowns readily available and able to be digested immediately.

Of course, Coronavirus could create a financial crash of its own, and if it is to, we may see a protracted crash like we saw with the GFC. Alternatively, we may see some great anti-viral drugs available in a matter of weeks and it could be business as usual for most businesses again very soon. Without a crystal ball we don’t know how this will play out.

What happened to dividends during the GFC?

Share price movements are only one part of the story, and for many long term buy and hold investors, the ups and downs of shares are secondary to the income they receive from them. This is particularly important for many Australian investors due to the traditional high dividend payout ratios of most companies, with a dividend in the 4-5% range expected of the major S&P/ASX 200 index.

Below we show the dividends of STW since 2005.

The above chart tells two very important things:

  1. STW dividends actually went up during the period of the crisis.
  2. Dividends fell considerably post crisis.

We’ll take a look at the reason for each of these.

Expect distributions to increase during market falls

When we take a look at the components of the distributions from STW during 2007 and 2008, the capital gain component of the distribution was much higher than in previous years. This explains who the franking percentage of the distribution fell from 50-60% to 30-40%.

There’s two main reasons why this happened:

1. Larger rebalancing activity

The STW ETF must track the market weighting of the largest 200 companies in Australia. The GFC saw some sectors hit much harder than others. For example the falls in Financial companies where greater than mining companies. As a result the weightings of the largest 200 companies changed dramatically. As a result STW would have had to sell some companies and buy other companies. This would have created capital gains for some of these companies, which must be distributed to investors.

2. More sellers than buyers

As ETFs have risen in popularity over the last 10 years, on any given day, week or month, in general there have been more buyers than sellers of ETFs, particularly the large and highly liquid ETFs like STW. This means in general when someone wants to sell a unit in an ETF, there will be a buyer on the other side of that transaction. In these cases no underlying shares need to be sold by the ETF provider and therefore no tax is realised.

However, in times of market panic, the ETF buyers dry up, but the ETF sellers are in full force. In these situations the market maker must buy back the units from the sellers and sell the underlying shares attached to them, thus realising capital gains. This is likely the cause for the majority of increased distributions during the GFC and we’ll likely to see this again this time around.

There are complex tax law provisions in place that allow capital gains to generally bypass the unit holders and be ‘streamed’ by the market makers, however it is our understanding that this works in normal trading environments, but can only go so far in selloffs like we’re currently seeing.

It’s a very important point to remember for investors, particularly those with high marginal tax rates, who have the most to lose from a tax perspective when they receive large distributions.

Dividend cuts are inevitable

Many businesses are battening down the hatches right now, to weather the coming storm of reduced economic activity. A strong balance sheet is therefore more important to them than maintaining dividend payout ratios. Companies on the front line such as those in the travel industry will no doubt cut dividends completely and may even need to raise additional capital to get them through the crisis.

For STW, an average dividend of $2.42 in 2005 and 2006 reduced to an average of just $1.44 in 2009 and 2010, that’s a reduction of about 40%. Only recently have we seen total dividends rise to that of the pre GFC levels. We can only speculate whether we’ll see the same sort of falls this time round and whether it will take as long to recover, but investors relying on dividends to fund living expenses or debt repayments should consider the possibilities.

Dividend Yields are a different story

The often quoted dividend yield number is simply the dividend divided by the share price. So when both share prices and dividends fall, the yield may not be impacted. Below we track STW’s yield based on the average share price of STW across each year.

Yields averaged around the 5% mark in the years pre the GFC, jumping during the GFC period (due to realised gains as discussed above) before falling to 3-4% in the post GFC recovery and stabilising at the 4-5% range each year since.

What’s the so what with dividends then?

The key messages are:

  • ETF investors should plan for some increases in dividends whilst volatility is present. There will be larger proportions of capital gains, which may create some shocks come tax time, where you feel poorer due to market conditions, but you owe the tax man more.
  • Those relying on dividends for their income should prepare for a reduction of dividends for a while (once the initial hit of realised gains washes through).
  • Those planning on buying into the weakness will be comforted by the fact that after some initial reductions in yield, dividend yield stabilised fairly quickly as economies recovered post the GFC.

Does history repeat?

The GFC was the first major crisis during the ‘ETF era’. Despite being a crisis based on vastly different circumstances, some similarities have already emerged. We have no idea when the current crisis will end and which businesses will emerge from the other side in a stronger position, but we’ve got no doubt the Coronavirus crisis, like the GFC, will be studied for many years to come.

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