The outbreak of the coronavirus COVID-19 has developed into an acute challenge for governments around the world as they grapple with the public health, social and economic ramifications. Inevitably this has been reflected in a period of more extreme market movements this week which although perhaps not at the same magnitude, can be expected to persist for some time.
There has already been a considerable impact on economic activity with the disruption to the global supply chains seen from the initial outbreak in China and progressing to the unprecedented actions taken by countries across the world to stem the spread of the virus, effectively shutting down significant parts of their economies and making a global recession inevitable. At the end of the first week of the UK shutdown considerable uncertainty remains over the path of infections from the virus, with forecasts of a peak in two to three weeks but with the prospect of restrictions for a much longer period. This is a global pandemic and events in other countries provide both an indication of how effective these drastic measures have been, but equally concerns over how the situation could deteriorate, the US being a major worry as it moves towards being the epicentre of the outbreak.
In such an environment it is impossible to say that stock markets have so far bottomed out, although over the course of the past week there have been some glimmers of hope. Italy’s coronavirus deaths appear to have reached a peak, suggesting that the country’s national shutdown has been effective in bringing the rate of transmission down. In China, restrictions are being lifted in Hubei province where the outbreak originated. Although other countries including the UK, are at varying stages of the progress of the virus, this does provide an indication of the possible course of events giving markets some ability to assess the impact.
Volatility may also subside as a consequence of the continued intervention of the financial authorities. After the initial monetary policy support measures including cutting interest rates to records lows, huge fiscal stimulus packages are being rolled out including the measures in the US due to be approved by Congress which will provide US$2 trillion to support businesses and workers through the crisis. Markets have responded very favourably with the US seeing the biggest three day surge in the Dow Jones Index since 1931. Governments around the world have taken similar steps, including the UK where extensive support packages have been announced to avert hardship in an attempt to ensure that the structure of the economy survives intact and is positioned to recover from what is effectively an induced recession.
Nevertheless the stock market is certainly discounting a period of recession and the main issue affecting the short term direction will be how long the restrictions on economic activity persist for and the depth of the resultant recession. Economic data is now starting to come through revealing the extent of the damage to economies worldwide including the record weekly unemployment figures in the US where 3.3m claims were registered by yesterday. Although the stock market still saw a substantial rise in the belief that the authorities are doing sufficient to ensure that jobs are not lost permanently.
What needs to happen to stabilise markets?
We are in an unprecedented situation akin to war in many ways but with greater economic and social restrictions than ever before. Although there is still unpredictability over how developments will unfold it is possible to identify key issues where action should provide investors and the public in general, with some confidence.
Firstly and particularly difficult, is the evolution of the virus and timing of the resolution of the health crisis which will eventually allow the restrictions on normal life to be eased. More testing of individuals to identify who has had the virus and progress on the development of a vaccine, would undoubtedly be positive steps.
The actions of central banks and governments has been unique and much more rapid and of greater magnitude than those seen during the 2008 financial crisis. For example the US government measures include direct cash handouts to individuals and in the UK generous schemes are being put in place to protect the income of the self-employed and temporarily laid off workers. Provided the crisis is time limited, these measures should enable a return to normal economic activity to occur more rapidly than is the case with a normal cyclical recession.
As companies start to report their earnings for the first quarter and economic data comes through showing falls in GDP, the hope is that the policy response has been of a scale sufficient to ensure that when there is some visibility in the health crisis, there will be confidence sufficient to encourage a relatively swift and robust recovery.
When we emerge from this crisis, there will inevitably be shorter and longer term consequences that will need to be considered. The extent of the state’s role in life, public spending on social and healthcare and higher taxation are all likely to be on the agenda . There will also be investment ramifications, for example, company dividend payments will be undoubtedly be lower for a period of time with the hardest hit sectors such as retail, travel and leisure suspending payments completely in many cases. Investors are therefore likely to need to adjust to reduced levels of income from portfolios particularly from the UK element where yields are typically higher. If recovery is robust though and company finances are stabilised reasonably quickly, dividend payments can resume and start to grow again.
Although the reasons and impact of this pandemic induced market slump have been different to previous market crises such as the oil induced shock in the early 1970s, the dot com bubble bursting in 2000 the run up to the Iraq War in 2003 and the global financial crisis of 2008, a common feature has been that recovery has always come through, often more rapidly than anticipated. It is impossible to predict the timing on this occasion though and exactly what the triggers will be, but it does seem that the efforts of the authorities to protect individuals from the worst impacts of the virus outbreak, both in terms of the health and financial implications, can be effective provided the more extreme measures in place are only there for a limited period of time.
Although remaining invested in equity markets is clearly an uncomfortable experience at this time, a suitably diversified portfolio with a focus on high quality businesses with strong finances, together with other assets with lower degrees of risk and of course cash, should provide a good basis to participate in recovery when it comes through.
27 March 2020