i-Wire: Market Update 16th
Market Update: All things must pass
- The weekend news from around the globe was truly shocking but the pandemic will come to an end in time, and financial markets do recover from these awful shocks however bleak it feels at the time.
- Currently there is no visibility as to either the eventual severity of the virus or its effect on global growth and earnings
- Until there is, markets will continue to trade on daily newsflow, not fundamentals or valuations.
- Markets need to see a strong and co-ordinated monetary and fiscal response from all the major economic blocs.
- We expect more of a gradual than a strong V-shaped recovery but with equity prices and bond yields higher by the summer months.
Coronavirus is spreading rapidly and horribly around the globe, turning our daily lives upside down in a way we would never have envisaged even two weeks ago. The weekend news was truly shocking as I don’t need to tell you. Our greatest concern is for the elderly, whilst the hopes and plans of all of us are now on hold for several months in this time of dreadful uncertainty; fear of the unknown is a terrible thing. To write about financial markets in this context may appear insensitive, but everyone must do their own job to the very best of their abilities at times of crisis. It is our role to help safeguard and grow your wealth, most especially in these difficult times, and in doing so try to give you one less thing to be anxious about.
Covid-19 is a global health crisis that has become a global financial crisis as financial markets rapidly discount the terribly damaging economic implications of social isolation, closed borders and whole countries now in complete ‘lock-down’. Stock markets have fallen by up to a third in the space of just a few weeks with a sense of panic almost unparalleled in their history.
This note will look at
- The lessons of history
- The economic impact of Coronavirus
- The required policy response from Central Banks and Governments
- What is currently discounted in markets
- What the shape of a market recovery may look like
- Our conclusion
The lessons of history
I’ve managed money through four market crashes, 1987, 2000, 2008 and now 2020 and it doesn’t get any less painful. The one thing I’ve learnt is that however bleak it feels at the time, markets eventually recover and go on to make ever higher levels. This may be very quick (1987) or it may be prolonged (2000/3) but recovery does eventually come. The 2008 crash, the great financial crisis, is most recent in our minds and though it may not feel like it today was probably a greater long term threat to markets. The following charts show the pattern of these falls in the context of a few years either side of the ‘event’ itself.
1987 was a ‘flash crash’ in a long term bull market that lasted from 1981 to 1999 and had no great economic implications
2000 was a crash resulting from extreme market overvaluation (the dot.com boom) and was more of a ‘Wall Street’ rather than ‘Main Street’ event though the recovery was more drawn out as the market dealt with a mild but protracted 18 month recession and the horrific events of 9/11.
2008 was the scariest of my 40 year career because that really did feel like the end of the world as the banks ran out of money, the financial system was in tatters and we stared into the face of global depression and social anarchy.
In the eye of all these storms the global stock markets looked on the brink of total meltdown with no prospect of recovery, yet recovery there was, and the long-term chart encompassing all these crashes puts it into perspective. 1987 barely registers, 2003 stands out for being a longer than usual bear market and from the long term viewpoint 2008 doesn’t seem that big a deal at all, which obviously wasn’t how we saw it at the time. The chart also shows the speed and severity of the current crash, making it almost unprecedented in stock market history.
Please don’t think for one moment I‘m being blasé or underplaying the risks of the coronavirus, either to our health or to the markets, because I’m not. I’m very concerned, not least because this is the most unusual of stock market crashes in that its origin are medical not financial. As such the markets will remain troubled and volatile until there is greater visibility firstly as to the spread and recovery rates of coronavirus and secondly as to its effect on global growth and earnings. At some point though, hopefully in the next few months, the peak of the pandemic will have been passed, and the markets will recover.
This is how we see things currently.
Economic Impact
Consensus initial downgrades were a hit of around 0.5% to an already lacklustre forecast of 2.6% for global GDP in 2020. These forecasts became out of date as soon as they were made as country after country declared national emergencies and closed their borders. The likelihood now is for a much bigger fall in GDP growth everywhere during the first half of the year, including the UK, and almost certainly a global recession. What we don’t know is whether this will be followed by a rapid V-shaped bounce as the world travels, shops and produces again in a wave of post-viral euphoria in the second half of the year (the bullish view); or whether we witness a shallow recovery and the onset of a multi-year disinflationary purdah (the call of the bears). Our sense is more of a U rather than a V shaped recovery but not a period of prolonged recession. One consolation is that the lessons of 2008 have been learned and commercial banks and the financial system in general is now much more robust.
The markets have been further unsettled by the halving in the oil price this year with the ‘double-whammy’ of a big fall on global demand colliding with the prospect of a supply surge following the fallout between Russia and OPEC. A lower oil price is normally good for growth but this fall-out is so spectacular and so badly timed that it is seen as a major negative as it threatens a wave of bankruptcies in the energy sector, especially in the US fracking sector.
Policy Response
The financial markets are desperate to see a strong and co-ordinated policy response to ensure the virus causes the least possible damage to global growth. As we wrote in our previous note, the Central Banks are doing their utmost but this is a global healthcare crisis and they cannot produce vaccines or cure diseases. The market was unimpressed by the 50bps emergency rate cut by the US Federal Reserve Bank raising fears that the ‘Fed put’ will no longer save the day. The ‘textbook’ response of a 50bps rate cut by the Bank of England combined with a strong fiscal spending Budget was similarly ineffective in the UK markets as they were looking for a co-ordinated global policy response .
The markets need to see a committed resolve by all countries to produce a strong, credible and combined monetary and fiscal programme with very cheap, easily available credit and liquidity combined with substantial government spending plans. The ‘big bazookas’ as they tend to be called in market parlance. The US Federal Reserve Bank signalled this intent on Sunday night with a 100bps cut in the Fed Funds rate, effectively to zero, and a re-introduction of a quantitative easing plan. We expect all Central Banks to follow this example, as well as announcing extensive fiscal spending plans. Thus far this has not settled market nerves, principally because the weekend news of lock-downs in Europe and a rapid spread of the virus in an arguably complacent and under-prepared US was truly shocking.
How much is already discounted by the Markets?
This is impossible to tell as we don’t know how severe the final impact of the virus will be, but currently the 20% + fall in stock markets, a substantial widening in credit spreads and a collapse in bond yields are pricing in the grim scenario of a global recession in growth and corporate earnings. So a lot of bad news is priced in but some sense of the spread and subsequent recovery rates from the virus, hard evidence of its economic impact and the scale of the policy response is needed before valuations and fundamentals rather than day to day newsflow begin to play a part in rational investment decisions. The news that China and Korea appear to be past the worst in terms of the virus gives at least a glimmer of hope.
When to expect a market recovery and what will it to look like?
Hmm, we reach the crux of the matter here. We need more visibility of course and we need to stop seeing the market up and down by 10% a day before we consider making/recommending changes to client portfolios. Nevertheless, my sense is that the market could look quite quickly through the awfully bad news we are going to be seeing in coming weeks assuming the policy response is forthcoming and the spread virus appears to be in some sort of control with high recovery rates. Our sense is that If the global economy is on the precipice then stock markets, which are discounting mechanisms after all, are already in the eye of the storm. Once markets have some confidence and found a floor we are expecting more of a ‘U’ rather than V-shaped recovery as the damage done to growth and earnings, and indeed to investor psychology, has been so severe. Thus, I would expect stocks to be higher, bond prices lower (i.e. yields higher) and credit spreads tighter (corporate outperforming government bonds ) by the summer months though still well down from market levels at the beginning of the year.
To re-iterate what we wrote in our previous note, we would not advocate long-term investors ‘cashing out’ of markets at current levels as they risk a significant loss of capital if they subsequently re-enter at higher levels when eventually we come through this awful time. Indeed, for clients with higher risk/reward tolerances or else those phasing money into markets this large these very steep falls offer a potential buying opportunity.
Conclusion
Three months ago we had never heard of coronavirus but the next three months are going to be a terrible challenge for us all. But the pandemic will eventually end and financial markets recover, though by how much and over what time period it is not yet possible to say. Hard as it is, we need to try and look forward to a summer of sunshine, of holidays and travel, of outdoor events and sport….and to resent rather than embrace all those toilet rolls cluttering up the back bedroom.
Above all else, we wish you and your families the sincerest of good health.
