Two widely publicised developments over the weekend had a significant impact on stock markets on Monday which were already weak in response to the coronavirus outbreak.
Firstly, an escalation in the spread of the virus in the West and the response measures, particularly in Italy, continues to trouble investors. This was compounded by the worst fall in the price of crude oil since 1991 as Saudi Arabia and Russia disagreed over how best to deal with the recent fall in demand, resulting from the outbreak.
This had a direct impact on oil producers in the UK market where there is significant exposure to the sector, particularly BP and Royal Dutch Shell. The expectation is that this dispute will be resolved in time as the price level reached is not in either country’s interest. More positively an eventual economic rebound may be strengthened by a lower oil price, supporting consumer spending power and reducing energy costs. Longer term, the carbon based energy industry faces challenges from the various renewable energy sources and nuclear. Geopolitical rivalry including the Russian aim to remove competition from US shale oil producers, may prolong the price war. The ongoing spread and response to the coronavirus remains of greater short term concern to markets, however.
How have markets moved?
The fall in global stock markets from February’s highs has been between 15% to 20% and with day to day significant market movements the figure is constantly changing. High quality government bonds have proven a safe haven and yields on US, UK and German government bonds have reached all-time lows. Gold and safe haven currencies such as the Japanese Yen have remained stable and at present money markets are not showing any significant degree of tension. The scale of stock market volatility to date is broadly on a par with that seen in previous recessions.
What is the economic impact?
The extent of the economic fallout of the virus outbreak is the key issue. It now seems inevitable that it will be significant as the type of more drastic action seen in Italy may be required elsewhere, inevitably suppressing economic and business activity. This will impact both supply and demand channels, at least temporarily. As has been shown in China and South Korea, draconian restrictions on people contact can arrest the spread of the virus once entrenched and a relatively short period of disruption may prove to be an economic price worth paying to avoid the much greater impact of a mass global pandemic.
There is no reason to believe that a recession now would be worse than usual with banks considerably stronger than during the financial crisis of 2008 and when the rate of infection slows, economic recovery may pick up significantly, aided by government and central bank policies which can mitigate the short term impact on business.
The Federal Reserve has already cut US interest rates and will likely do so again. The Bank of England and European Central Bank are likely to follow suit and emergency liquidity provision is likely, for example providing businesses with tax payment deferral, as is extra government spending. Lower interest rates alone will not encourage concerned consumers to begin to spend, but as a part of a package of measures, particularly if carried out on a co-ordinated global basis, the extent of economic dislocation can be limited avoiding long lasting damage to the economy. One enduring impact though will be that interest rates look set to remain lower for even longer than previously anticipated.
With any sharp market fall there is potential for a rebound and opportunities to be taken advantage of. Recent developments have complicated the near term risk and uncertainties investors are facing but markets do discount bad news and the extent of recent share price falls suggests that significant economic contraction is already factored in.
Inevitably news headlines during such periods can create concerns for investors, leading to the temptation to consider ‘knee jerk’ changes to portfolios. This is rarely the best course of action. Longer term a diversified portfolio with a range of asset classes helping to offset some of the market volatility, while maintaining the opportunity to benefit from recovery when it comes through, has proven more effective.
There is no reason at present to believe that the virus outbreak in the West should not be brought under control, as now seems to be the case in China and that economic activity cannot return to near normal in a relatively short period of time. But until there is evidence that the coronavirus outbreak is under control and the extent of the economic disruption is clearer, further market weakness will remain a risk and turbulence should be expected during this period.
During these difficult times for investors, it is important to remember that the long term trend of returns from equity markets consistently outperforms less volatile assets such as cash and bonds, while providing protection against the impact of inflation and a source of income through dividends. There will inevitably be spells of weakness in response to political, economic and in this case social/public health factors, but long term investors with suitably diversified portfolios have generally been rewarded.
10 March 2020