Market update and budget review 20th March, 2020
WHERE DO MARKETS GO FROM HERE?
Global stock markets have again experienced massive volatility this past week. Trading on the New York Stock Exchange (NYSE) has been halted 4 times in 2 weeks due to extreme market movements, although it should be noted that one of these suspensions was because the S+P 500 jumped by the trigger limit of 7%. The market continues to react well to positive news, in the form of increased government intervention, but the pattern appears to be that when the figures are digested concerns about the depth of the virus resurface and any gains are eroded. In percentage terms the monthly falls market falls are 28% for both the FTSE and Dow Jones Index, 32% for the DAX (German stock market) and 25% for the S+P 500. Conversely, one index that has given a positive return is the volatility index (VIX) which is commonly referred to as the fear index. This, as the name suggests moves as market volatility increases or decreases and in this month, it has risen by 48%. A good hedge if you were quick enough to get in at the beginning (all figures as of 20/03/20).
When confronted with such drastic falls it is sometimes hard to try to stay positive and to look beyond the next few weeks, or potentially months and have belief that as and when the virus passes markets will return to some kind of normality. So, with this more upbeat mindset we should look to see where we may be in the future. Clearly any such optimism is not to be taken as being flippant to a health scare that is all too real for so very many people.
Firstly, world governments seem to realise that this situation is unprecedented and therefore their reaction and intervention must also be of a level not seen before. The US has announced a package worth around a trillion dollars, and which may include so called “helicopter payments” of real cash into the hands of those most in need. Furthermore, as I write, markets are trading up because of a Reuters story claiming that China is about to release a fiscal stimulus package of “trillions of Yuan”. All governments are trying to offer as much assistance as possible to get people through the coming months, often with an effectively open cheque book. When the UK Chancellor, Rishi Sunak, presented his budget last week there were echoes of Mario Draghi with his famous promise to “do whatever it takes” to save the euro in 2012. The Chancellor pledged that any and all tools and fiscal stimulus available to him would be used if required and, unlike Draghi for whom the promise was broadly enough to save the currency, Sunak has had to back the speech up with further actions. He announced a package of measures to help small business and individuals that will cost £330BN, with the promise of more to come. There is well founded criticism that the rescue package doesn’t help everyone, people who rent and the gig economy workers in particular seem left out currently, but extra measures are announced daily, and it would be hoped that these will be addressed. It is perhaps worth remembering that many actions have unforeseen consequences and, provided the assistance is given shortly, it is probably prudent that the delivery of any measures is done with some consideration.
Another point to consider is the nature of this sell off and how it compares to other economic shocks to the markets. Broadly speaking there are 3 main triggers for a bear market, and each shows different characteristics in terms of depth of fall and duration until recovery.
The first scenario is a structural problem, which would be best seen in the financial crisis of 2008. Here the global economy and banking system came close to collapse due to systemic problems. Although there were several catalysts for the crash, it became a real problem because banks were under regulated, under prepared and over exposed, especially to derivatives that had huge leverage attached. Credit dried up and many businesses failed due to lack of available funds. From its pre-crisis level of 14,164 (09/10/2007) the Dow Jones index fell by over 50% to 6,594 (05/03/2009). Although stock markets have risen in the last 10 years, especially in the US, this has largely been due to ease monetary policy (low interest rates) and it is questionable that the broader global economy has yet fully recovered from the events of 2008. Importantly, in the interim banks have been more closely regulated and stress tested and are now in a much sounder position.
The second trigger can be described as a cyclical shock, generally a recession. Although the events of 2008 led to a recession, that was structurally driven rather than cyclical, so we have to go back to the early 1990 to see the last recession of this type. On average such a cyclical shock will last around 2 years, sees market falls of roughly 30% and takes a little under 5 years to recover (source; Goldman Sachs “the type of bear market matters”)
The third trigger is event driven and here the best example would be the aftereffects of the terrorist attack on the World Trade Centre in 2001. Stock markets were suspended for 6 days but upon reopen the Dow Jones fell by over 7% (there were no circuit breakers at this time) which was the biggest ever one day fall before recent events. However, the market recovered quickly and within a month the Dow was trading at pre 9/11 levels. Historically, an event driven bear market lasts 8 or 9 months with a recovery taking around 18 months (source; as above).
Obviously, it is too soon to say with certainty how long this current crisis will last but there are some more positive signs. There was a more encouraging tone from the Prime Minister last night suggesting that his advisors hope we could be past the worst of it in 12 weeks and the reporting of new cases has slowed significantly in China, where of course the virus originated. Furthermore, there have been reports about potential vaccines being tested that may help ease the situation and some pre-existing drugs have also been used with some success. If markets see the situation as being event driven and it doesn’t cause excess structural problems, we could hold some hope for a relatively swift market recovery.
The last bit of positivity to cling to is that the nature of this sell off has been all encompassing, meaning some very good companies have been driven down with the rest. While it may be doubtful that certain sectors, such as airlines, stage a rapid recovery as the crisis passes, it will almost certainly be the case that some sectors have been oversold and there will be the opportunity to buy quality stocks and a considerable discount. Investors might hope that any fund managers will soon be earning their fees by searching out the bargains to be had. It is also fair to say that the equity bull market of the past decade was running out of steam and that the market was due a correction. Furthermore, while no one would have wished for it to come in these circumstances, it may be that a degree of sanity may return to the market. Perhaps the days of companies such as WeWork being given astronomical valuations while haemorrhaging investors cash, are over?
Author Trevor Hubner