What a difference a month makes. Global markets are fully in risk-off mode as COVID-19 escalates into a global pandemic. Last month, we noted that markets shrugged off the risk COVID-19 posed. This month, we take a deeper look at the implications of COVID-19 on the global economy and markets.
At the time of writing, we are on the cusp of a bear market in the U.S. for the first time in 11 years, the sell-off in 2018 came within 1% of a bear market, but with overnight futures pointing 4% lower, it is likely that this bull market has finally been killed.
The drawdown has been quick and severe, with the U.S. peak coming just three weeks ago, it is the fastest sell-off in post World War 2 history. The U.S. S&P 500 is down 18.9% over the past month, not including the 4% drop in overnight futures. Meanwhile, the S&P/ASX 200 has fallen 25.2%, the Euro Stoxx 50 is down 24.6% and Japan’s Nikkei 225 is down 22.2%. Meanwhile, China’s CSI 300 fell 0.84% in the same period, and is one of the only major indices still positive for 2020, alongside the NASDAQ.
Commodities continue to suffer as economic growth forecasts are dialled back and the oil market was savaged as Saudi Arabia and Russia could not agree to another production cut, leading to a potential price war when current output restrictions expire in April. Oil prices tanked 36% whilst copper continued last months slide, falling 5.4%. Conversely, iron ore rebounded from last month’s falls as Chinese activity starts to return. Gold bounced 4.6% on safe haven demand, which seems small relative to the sell-off in other parts of the markets.
Safe haven bonds are up strongly as central banks implement emergency cuts across the world, with the U.S. 10-year yield falling 0.86% to 0.77% and the Australian 10-year yield falling 0.29% to 0.76%. These figures mask the volatility within safe haven markets as well, with U.S. 10-year yields dropping below 0.4% at one point. Meanwhile, credit markets fell as high yield spreads blew out on fears of rising default rates.
The Australian Dollar fell to 64.5 U.S. cents.
Economies are in turmoil as COVID-19 disrupts trade, travel and movement. Economic data generally comes at a lag of one or two months so stronger than expected U.S. jobs reports and better than expected European manufacturing and industrial activity from previous months mean little now apart from telling us that economies were rebounding from the trade war prior to the COVID-19 outbreak.
The ones that incorporate the impact of COVID-19 are the collapse of China’s Manufacturing and Non-Manufacturing Purchasing Manager’s Indices which indicate economic activity. Both had a precipitous drop deep into contractionary territory as one would expect when a country shuts down for weeks. With the coronavirus spreading rapidly as part of the second wave of infections (also mentioned as a likely risk in last month’s edition), expect the rest of the world to see a similar sudden drop in economic activity as cases ramp up in Italy, South Korea, Iran, the U.S., and the rest of Europe.
As such, central banks globally have gone through a round of emergency interest rate cuts. Australia has cut 0.25% and the U.S. cut 0.5% outside of a regular meeting. Canada, England and many Asian countries have followed suit. There is also talk of further global monetary easing in the form of further quantitative easing measures from the likes of the Federal Reserve, European Central Bank and Bank of Japan.
Coupled with monetary easing, many countries have announced emergency fiscal stimulus measures including loan support for individuals and small businesses, tax relief and additional healthcare budgets among other measures. In Hong Kong, there is even the use of so-called ‘helicopter money’, which basically means the government gives everyone cash to spend.
Given this backdrop, markets remain volatile as investors can only guess as to how long and how bad COVID-19 gets, and how much of an impact monetary easing and fiscal stimulus can have when fear or survival instinct prevents people from leaving their homes.
The unpredictable spread of COVID-19
COVID-19 has become a global pandemic, disrupting economic activity globally. China looks to have the situation under control a couple of months after the virus started breaking out. Meanwhile, the outbreak is at its infancy in the U.S., whilst it is probably at the acceleration stage in Europe. It is unlikely that other countries can curb the spread as quickly as China given the relative freedom enjoyed by the population in Europe and the U.S.. On the flipside, healthcare systems in Europe and U.S. have been assumed to be better than China. Realistically, all one can do in terms of trying to guess when the global situation will be under control is just that – hazard a guess. There are too many variables for a reliable estimate, and therein lies the issue for investors. People hate uncertainty, and COVID-19 has proven itself to be different to recent virus outbreaks due to the long incubation period and large portions of mild or asymptomatic cases, making it much harder to detect and therefore contain. Since people make up the markets and global economy, this uncertainty hurts market sentiment, business sentiment and consumer sentiment, stopping spending in its tracks.
The question is how long will it take and how much pain will the global economy feel in the interim? As alluded above, the first question will be hard to answer, policy makers are taking extreme steps to curb the spread, including travel bans and forbidding large public gatherings but this will exacerbate the sharp drop in economic activity. As for the second, policy makers are also taking steps to mitigate the pain.
Apart from looking for a cure or vaccine for COVID-19, policy makers are looking to treat the ails of their respective economies. It is generally accepted that COVID-19 will not be fatal to the world and that the pandemic will eventually be contained and life will return to normal, but markets are worried about are whether some businesses will not survive to see it as shown in the charts below.
This comes in two general forms; monetary easing through interest rate cuts and quantitative easing, and, fiscal stimulus through government spending, tax cuts, loan forgiveness and other measures. Investors are very familiar with the former, having never really got off this form of medicine since the Global Financial Crisis. The issue with monetary easing is that the effect has diminished given low starting interest rates and already swollen balance sheets, with recent studies showing negative rates to be ineffective and potentially having the adverse effect than intended. The effectiveness of monetary easing on this problem is also questionable given that the economy is not undergoing a financial crisis caused by cost of funding or liquidity.
Hopes are on fiscal stimulus but big budget deficits and high debt levels in U.S. and other large economies leaves concerns over the size of stimulus as funding becomes a stumbling block. Europe is the outlier here following years of fiscal austerity, they have room for a significant stimulus package, however willingness to do so is another story, with Europe still suffering scars from the European debt crisis. Fiscal stimulus is likely to be more effective in combating this particular slowdown as it can be more targeted and flexible to address specific areas such as freezing loan repayments for the travel industry.
Many countries are already implementing both forms of economic medicine but markets and investors are unconvinced of the effectiveness of policies announced so far. Indeed, it is likely that governments will continue to provide additional monetary and fiscal stimulus in the weeks to come in the effort to stave off large scale defaults. Some defaults are to be expected of course, but the key for markets over the next year is to prevent a pandemic of defaults, the effects of which may last long after the virus itself is contained. Though the economic impact has varied for different viruses due to scale and length of the outbreaks, policy makers have historically been successful in this effort and markets are usually quick to recover once an outbreak is contained. This time is probably not different so investors should remain calm and continue to monitor the situation as market volatility may present opportunities.
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This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
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