Given the fall over the past few weeks, it looks pretty grim. The S&P 500 has plummeted 33% since its year-to-date highs in February leading the Federal Reserve to announce unlimited quantitative easing measures earlier this week.
However, unlike the Global Financial Crisis (GFC) in 2008, the current volatility does not have the world’s financial system as the locus of failure. It does, however, have a huge economic and social impact which has been reflected in market activity.
In fact, such is the trauma being caused that market commentators are somewhat at a loss to compare it to any other period they have experienced. Certainly, the speed of the unfolding crisis is taking many by surprise.
“I have seen market and economic crises over the past four decades I have been in this business, and this crisis is evolving faster than any in my lifetime,” Rob Arnott, founder and chairman of Research Affiliates, said in a webinar earlier this week.
He went on to warn that attempting to fully understand what is happening and what it might mean for the global economy falls into the trap of ‘nowcasting’.
“Nowcasting can lead us astray because events are still unfolding,” he suggested. “Today’s numbers will quickly become quaint as the number of cases of COVID-19 rises around the world. Today’s ‘now’ is the tip of the iceberg – so do not get anchored to it.”
In other words, the true picture of what the economy will look like after this “nuclear winter” will take time to unfold.
Assessing the damage
Totting up the costs of the crisis right now is akin to putting together an exact insurance claim while the hurricane is still raging outside. But it is possible to remain objectively optimistic that the financial system, once the world regains its poise, will bounce back.
“On the whole, the financial markets have held together fairly well thus far, with lots of help from central banks,” said Peter Sleep, senior portfolio manager at 7IM.
“Markets stayed open and financial connectivity has been surprisingly good, fingers crossed. The commercial banks are much more solid than in 2008 and the generation of central bankers who cut their teeth in the Global Financial Crisis are still around to apply the lessons they learnt back then.”
Jesper Koll, senior adviser to WisdomTree, pointed out that what will be needed in all western countries is policy coordination. “You need to support both big industries, plus smaller companies and the health system,” he said.
“This is not the GFC or other previous crises. This is not the financial system freezing before we get policy action. It has not really seized up and the reality is the stresses and strains are much, much lower than it was during the Lehman crisis.”
The great leap forward
Still, there will be huge changes to the economy post-crisis with, as Arnott said, many businesses going bust simply because we will not collectively be flying, going out or otherwise fuelling the consumer economy as we were.
“But roll the clock forward five years and the many surviving businesses will be faring well, some with fewer competitors, and on top of that, some industries will have fewer zombie companies,” Arnott added.
Koll made the point that in a post-crisis environment there will be a “release of tremendous pent-up demand”.
“Then the question will soon turn to how quickly do you withdraw the life support,” he added. “In blunt terms, how quickly do you raise interest rates? It might seem a horrible thing today, but this is where the true independence of the central banks will be tested.”
Sleep suggested government policy will tend towards the socialist for some time to come. “Most governments will spend a great deal and bail out lots of firms and households in the next year or so,” he predicted.
“At some stage, someone will have to pay for this and I suspect that the owners of capital could have to contribute. Lenders may have to forgo interest payments, landlords may have to waive rent and we may see a Robin Hood tax on transactions or charges on capital. This may seem reasonable given that we have all suffered this virus together.”
Back to buying
As ETF Stream has written about earlier this week, the situation in Japan once the stimulus period has passed will be that the BoJ will effectively own 10% of the stock market.
“What is the exit? There is not even a theoretical exit,” said Koll. “For the purchases to have an effect you do need to start to see the private investor, and domestic institutional investors, agree that this is a good time to buy Japanese equities.”
As for investors elsewhere, the questions revolve around age-old issues of market timing and asset allocation.
Sleep said 7IM has always stressed the need for diversification across equities, bonds, currencies and alternatives to help protect clients’ capital.
“Investors have been strongly reminded of the value of diversification in the last few weeks,” he continued. “Diversification has been a powerful tool once again.”
As for the issue of timing for any recovery, as ever when markets are falling, caution must be exercised with all the usual caveats about attempting to catch a falling knife coming once again to the fore.
Yet as Arnott concluded this week, the stark fact is that the stock markets will recover long before the pandemic is consigned to the history books.
“The strongest bull markets are not built on a foundation of good news, but on diminishing bad news,” he said. “It will be hard to be perfectly right on the turning point, naturally, but don’t wait for the good news—just wait until the pattern of bad news lets up.”
Judging that point could well be the million-dollar question. “A lot of bad news is coming at us, with some dangerous times ahead, but as fear peaks in the weeks to come, the time will also come when bargains make themselves obvious to the naked eye of the disciplined investor. The window of opportunity as always will be short, but highly rewarding over the longer term.”