Global pandemic – entering period of unprecedented economic events and market volatility

Darius Svidleras
Investment Portfolio Manager

• Acceleration in global spread of COVID-19 continues, while most developed countries are rapidly entering recession;
• Equities experienced one of the  most extreme price swings in history, setting various price change records throughout the month and entering bear markets;
• Unprecedented amount of both monetary and fiscal stimulus was announced globally in March to withstand negative economic consequences and attempt to stabilize financial markets;
• Future performance of financial assets would depend on how fast countries are able to return back to normal life, how effective would turn out implemented monetary and fiscal measures, and whether coronavirus did not trigger processes of deleveraging and deflation.

By any criteria, March was historic month that will be remembered for a long time to come. Number of coronavirus cases around the world was constantly increasing, and in more and more countries COVID-19 epidemic was getting out of control. For the most of March most disturbing virus trends were registered in Europe, especially Spain and Italy, but by the end of the month around one fourth of all global cases became attributable to USA. As a result, governments had to implement radical quarantine measures to contain the spread of the virus, such as closing borders, prohibiting international travel, limiting movements inside their countries and putting various restrictions on how businesses should operate.

Daily global & USA coronavirus cases

Source: Bloomberg

These are efficient measures to save lives and protect health of citizens but, unfortunately, such measures come at a cost as they also lead to extremely severe economic damage. As large share of companies stop making services or producing goods, while consumers sit home and do not make any purchases¹, revenues of such enterprises abruptly become almost non-existent. In its turn, companies have to start cutting costs almost immediately, by reducing number of their employees, abandoning investment plans for future growth and undertaking other measures to save money, be able to repay debts and not go out of business. This is not exaggeration, already in March most severely hit industries, such as airlines, hotels, cruise lines and others were asking for government bailout, as risks of them going bankrupt were rapidly increasing. As a result, industries that were considered relatively stable just in February went down in price by as much as 60% in less than one month.  

Performance of S&P-500 and selected industries in 2020

Source: Bloomberg

Macroeconomic consequences also become very discouraging. From available numbers, we have already seen record low economic activity in services industry in USA and Eurozone in March, and extraordinary high rise in initial weekly unemployment claims in USA. During only two last weeks in March, around 10 million US citizens have lost their jobs, and in the upcoming weeks this number may become even higher. And though it is still too early to make reliable forecasts for the upcoming months, according to Goldman Sachs in second quarter 2020, US economy may shrink at around 8% compared to first quarter 2020, and unemployment may soar up to 15% by mid-year. 

Services PMIs

Source: Bloomberg

US initial weekly unemployment claims

Source: Bloomberg

For financial markets developments in end of February and March were also totally unexpected. In mid-February, equity markets were updating new all-time highs, and there was consensus among market participants that COVID-19 spread would be mostly limited to China and some isolated cases elsewhere. However, when evidence from other countries started to indicate that risk of global pandemic is rising, panic at financial markets went to unprecedented levels.

Never in history equity markets declined from the top by 20%² in such short period of time, and only during Wall Street 1929 crash and October 1987 immediate drop from the top was so significant. In addition, never in history, consequent 20% rally after such crash happened in such short period of time (3 days). If we take statistics on largest daily changes for S&P-500, during March index registered third (-11.98%) and sixth (-9.51%) largest daily declines ever, and also registered ninth (+9.38%) and tenth (+9.29%) largest increases ever. Not a single month in history was able to generate such abnormally high up and down volatility.

Worst declines from S&P-500 all time high in history

Source: Bloomberg

Best and worst S&P-500 performance by days

Source: Bloomberg

To provide economic support and help stabilize financial markets, central banks and governments had to announce record amount of monetary and fiscal stimulus. The list of taken actions is truly large and we will only mention most significant ones:

• During two emergency meetings FED cut interest rate from 1.75% to 1.25% and consequently   to 0.25%;
• FED announced that it would purchase unlimited amounts of treasuries and mortgage-backed securities, in essence launching unlimited quantitative easing;
• US government introduced 2 trillion stimulus package to help businesses and individuals in USA cope with crisis;
• ECB announced Pandemic Emergency Purchase Program with EUR 750 billion available for purchase of public securities;
• Germany launched EUR 750 billion fiscal package;.

Even during 2008-2009 financial crisis amount of stimulus was not as large as during one month of March, so these measures are indeed exceptional. Hopefully, they would allow to smooth negative economic impact from COVID-19 and speed up recovery after pandemic is behind us. This is why, financial markets were able to somewhat stabilize by the end of March and recover part of their losses.

If world will indeed be reopened in the nearest future, with new money entering economic and financial system through stimuli, economic growth would return and inflation would pick up.  Asset prices in that case may experience strong rally. Since 2009 every time FED increased its balance sheet and launched QE programs, equity prices rallied subsequently. Will it be different this time?

Increase in FED balance sheet vs performance of S&P-500

Source: Bloomberg

Unfortunately it might be different this time. As we constantly described in our overviews throughout 2019, even without coronavirus impact, global economy was already in late cycle and running close to maximum capacity, while too much debt was used unproductively. For example, already mentioned airlines were actively buying back their shares from the market by issuing new debt, but now do not have adequate cash reserves to survive without government aid. So even after coronavirus crisis is resolved, there is no guarantee that countries would be capable to return to previous levels of growth fast enough.

In addition, it is absolutely unknown, how long would it take for coronavirus situation to resolve. Even if life is back to normal in affected countries after several months, who could guarantee that there would not be second wave of virus spread say in autumn, similar to how it happened during Spanish Flu epidemic in 1918. As a result, with future being so unpredictable, companies and individuals may become reluctant to spend money, take new debt and increase consumption even after crisis is over. Companies would continue to reduce costs by cutting labor force and not undertaking new investments. In such scenario deflationary pressures would be significant, recession would last longer than planned and financial assets would continue going down in price.

Long term inflation expectations

Source: Bloomberg

This is exactly why governments and central banks have acted so fast by introducing such enormous stimulus packages. We hope their actions would be enough to prevent more prolonged depression.  In times of such unprecedented uncertainty and extreme volatility it is especially important to stay rational and stick to your investment plan. If your goals and financial circumstances have not changed, the movements in the market are not a good reason to change the plan. Additionally, it usually doesn’t pay off trying to catch a bottom, as it is extremely hard. However, using regular contributions to long term investments may be a good way to take advantage of lower prices in the market.

¹Apart from basic necessities