We’re still in the early stages of the Coronavirus outbreak. But have we reached the end of the beginning of the market crisis it has triggered over the past month or so? A period of extreme volatility, including record rises and falls on consecutive days, came to an end last week as investors decided governments and central banks now have their back. The US’s $2trn support package, in particular, backed by the Fed’s whatever it takes approach to monetary stimulus, has seen stock markets stabilise.
Evidence is growing that bargain hunters are returning to markets around the world, with bullish investors now believing that March’s sharp falls have thrown up some remarkable buying opportunities. Last week saw global markets rise by 10%, the best weekly result in at least a decade, with Japan leading the pack, up 17% in dollar terms despite the postponement until 2021 of the Olympics with the economic hit that entails. Last night the S&P 500 added another 3.4%, although global markets are still on track for the worst quarter since the last three months of 2008. For the UK, it looks like being the worst quarter since the 1987 crash.
Investors are taking the view that, calamitous as a global economic lockdown might be, it is not a re-run of the financial crisis. The expectation is that a sharp slide in both GDP and corporate earnings this year will be followed by a robust recovery later this year and into 2021. Twelve years ago, a credit crunch triggered recession and a slow recovery as the world’s financial plumbing seized up and business and consumer confidence was hit hard.
This time the hope is that a dramatic slowdown will quickly rebound thanks to measures taken to cushion the blow for both companies and individuals. The focus is on keeping people employed, even if temporarily sent home with nothing to do, or furloughed. The idea is that keeping people in work will ensure that once we are allowed out of our homes again, our willingness and ability to spend will quickly put the economy back on track.
If that is how things pan out then the sharp fall in share prices, down by a third or more at their worst a week or so ago, may prove to be an over-reaction. Certainly, the extra return offered by shares compared to bonds - the so-called equity risk premium - is now at its highest level since the Eurozone sovereign debt crisis of eight years ago.
The authorities’ support, together with attractive valuations, are two necessary but probably not sufficient measures for a sustainable improvement in markets. The third requirement is better news on the medical front. A peaking in the rate of infections, particularly in the important US market, is needed and that remains some way off.
The infection and death numbers are still rising in both Europe and the US even if there have been tentative signs on this side of the Atlantic that the rate of increase may be starting to slow.
Not all parts of the economy will behave in the same way as the crisis unfolds and investors remain concerned that some sectors are grinding to a halt as travel, retail and leisure are hit by the lockdowns now affecting a large proportion of the global population. In many cases, investment remains a binary bet - if a company survives the next few months then its shares are probably too cheap. But many businesses may not survive.
Pockets of real distress are emerging. In the UK, retail landlords are starting to threaten legal action against tenants who say they won’t pay their rent. Airlines are cutting back their schedules to bare bones or, in the case of EasyJet, grounding their fleets entirely and looking to defer or cancel orders of new aircraft. Airbus’s shares fell 10% on that news.
Meanwhile the economic data, which tends to be backwards looking, is only just starting to confirm what analysts have been forecasting for some time. Economic sentiment in the UK and across the Eurozone was dropping in the first half of March even before restrictions such as social distancing were imposed, according to the latest figures from the European Commisssion. In Europe the fall was the biggest since records began, driven mainly by a collapse in sentiment in Italy, perhaps the best guide to where other countries in the region are headed.
In the US, last week’s announcement that more than 3 million people registered for unemployment benefits was a shockingly large figure but unsurprising given the high proportion of US people that work in the worst affected sectors such as retail. This was a worse figure by a large margin than even the worst weeks during the great Depression in the 1930s.
Attention will focus later this week on the US non-farm payroll report, although this will not show the full impact of lockdowns which happened after this data was collected. Bank of America forecasts a rise in the unemployment rate from 3.5% to 3.7% this month but expect a doubling to 7% by next month’s figures. The St Louis Fed has made a ‘back of envelope’ prediction that US unemployment might reach 50m people or a 32% unemployment rate.
The first glimmers of hope are showing through in China, however. Overnight, the purchasing managers index for manufacturing there rose to 52. Anything above 50 signals growth and the latest reading compares with 36 in February.
The other big market news this week has been the performance of oil, which saw the US WTI contract fall below $20 a barrel, its lowest level for 18 years as traders bet that production would have to stop completely in response to a dramatic drop in demand. It is estimated that consumption of crude oil could fall by a quarter in April due to widespread lockdowns. The widely traded Brent contract was little better at less than $23 a barrel, also the lowest since 2002.
The drop in demand has been compounded by an increase in supply following the collapse of an output reduction agreement between OPEC, led by Saudi Arabia, and Russia. That had been supporting the oil price in the face of new supply from North American shale fields. Now the market is awash with new barrels of oil with increasingly few storage facilities available in which to park the over-production.
It is now thought that 25m barrels of oil a day is surplus to requirements, which could overwhelm storage in a matter of weeks. The traditional producers are betting that the shale fields will blink first, shutting down production of below-cost oil. But it is a huge gamble for countries that are dependent themselves on oil revenues.
The only silver lining to the oil price war is the way in which cheap oil might underpin the economic recovery when it does begin. Cheaper petrol, heating costs and less expensive inputs for industrial companies will give the economy a much-needed boost in due course.
The challenge for the energy sector is likely to show up in time in the ability of companies like BP and Shell to pay the generous dividends that support many investors’ income strategies. Across the board, dividends are under pressure, not least because companies quite rightly realise that they cannot be seen to be rewarding shareholders at the same time as they trim their workforces or accept pay-outs from the taxpayer.
On the face of it, dividend yields underpin stock markets at today’s depressed levels but that is only the case if forecast payouts are actually delivered. In many cases they won’t be, and announcements of dividend cuts are becoming a daily occurrence.
Another widely-watched asset during times of stress is gold, which rose more than 8% last week to $1,626 an ounce. It was the best week for the precious metal since 2008. Inflows into gold-backed ETFs have rebounded so far this year and investors are buying bars and coins too. Gold is particularly attractive when interest rates are low because the opportunity loss of investing in an asset that pays no income is reduced. Gold is also attractive to investors who fear a return of inflation, which is a possible by-product of the extraordinary stimulus being implemented by governments around the world.