Since the coronavirus outbreak was labelled a pandemic earlier this year, global financial markets have suffered a sharp downturn and dropped into bear market territory within an incredibly short timeframe. To put the speed of the drop into context, it took 188 trading days during 2008 for financial markets to drop into bear territory and even the 1928 stock market crash took 30 trading days to reach this point. By contrast, the market crash this year took only 16 trading days.
The speed of this drop can be attributed to several factors. The initial reports and death tallies coming out of China were alarming and the WHO was quick to label it a Public Health Emergency of International Concern. A research paper published in The Lancet produced modeling that predicted widespread infection and death rates both in China and, potentially, for the rest of the world. Based on these studies China implemented an aggressive lockdown across Wuhan and the Hubei province with investors and traders left panicking about the contagion and spread of the virus itself. They were also concern about the lockdown of one of the largest economies in the world and whether other countries would also face similar measures in the weeks and months to come.
At around the same time as these events unfolded in relation to the coronavirus pandemic, the price of crude oil dropped heavily on the back of ongoing difficulties amongst oil-producing countries in relation to global supply levels. This breakdown of talks, primarily between Saudi Arabia and Russia, has led to an oversupply of oil, which in combination with a drop in demand, has seen the price of oil fall to levels not seen for many many years. Either of these two events would be cause for concern, but in tandem, they sent shockwaves rippling through the financial markets.
Despite the level of fear dominating much market activity currently, Foresight Wealth Strategists, along with a number of analyst reports from J.P. Morgan, BlackRock, Russell Investments and others, are predicting the strong potential for a sharp rise in market valuations once this crisis has abated. There are a number of reasons to be optimistic about the prospects of a sharp recovery.
Whilst the speed of the crash in financial markets has been breath-taking, central banks and policymakers around the world have acted quickly to provide fiscal stimulus to financial markets. The US and the UK cut interest rates twice to their lowest levels on record (0% in the US and 0.1% in the UK) Additionally, both countries, in concert with the European Central Bank (ECB), have massively stepped up the scale of their Quantitative Easing (QE) programme with all three central banks pledging unlimited sums available in the form of QE.
QE is the process whereby central banks issue currency in order, principally, to buy up government debt in the market. This provides liquidity in the market at a time when institutions’ finances may be under severe pressure. As the scale of QE grows there is scope for central banks to also purchase other assets.
The impact of lowering interest rates combined with hundreds of billions of dollars, euros, and sterling in QE has a highly distorting effect on the bond market with the yields being forced down. Currently, the vast majority of government debt is providing a negative total yield in relation to inflation. In order to achieve this compression of the yield curve the capital value of the bond is driven up enabling existing bondholders to sell their holdings to the government at a profit.
The resulting impact is that where financial institutions, such as pension funds, insurance companies, etc, would normally hold a portfolio of government bonds in order in order to meet their liabilities, these institutions are now forced into buying riskier assets, such as equities, in order to meet their liabilities. This will likely mean a large volume of funds being transferred into equity markets driving market prices up in a very similar mechanism to what happened in 2009.
Over the course of this crash equity markets have fallen as outlined above, whilst at the same time, bond market valuations have risen. This has meant that many long-term investment portfolios have seen their asset allocation become skewed. It is normal practice for portfolio managers to rebalance their portfolio back to their desired asset allocation on a regular basis. According to J.P. Morgan, pension fund reallocation is likely to create additional investment into the equity market of between US$400 billion and US$600 billion over the next quarter or two. This shift of capital being reallocated into equity markets is likely to contribute to upward pressure on valuations.
Further Fiscal Stimulus
In addition to the lowering of interest rates and quantitative easing, central banks across the US, UK, and Eurozone have also provided additional funds in the form of overnight loans and a variety of mechanisms that allow banks and market counterparties to access liquidity should it be required. In the US alone this additional liquidity is being provided at a rate of up to $1 trillion per day. The primary purpose of this additional liquidity is not to bolster equity markets or asset prices, but to ensure that market counterparties have adequate funds to continue meeting all obligations and payments across the market.
This should help prevent the collapse of any financial institutions, as in 2008 when Lehman Brothers and Northern Rock failed causing a breakdown of confidence in the global banking system. By providing the liquidity to maintain solvency and confidence in the system, we expect market activity to remain active throughout this crisis and that investors, financial institutions and market counterparties will have sufficient confidence to resume business at normal levels once greater clarity on this crisis is established.
Pent-up Consumer Demand
There is no doubt that the coronavirus pandemic has had a huge impact on the global economy. This is largely due to the fact that governments around the world have implemented largescale lockdowns in an attempt to contain the virus. The consequences, economically and socially, of shutting down society are potentially huge and could leave millions of people unable to pay rent or buy basic essentials, such as food. Additionally, many businesses would be likely to fail creating large numbers of jobless people adding to the potential economic malaise.
Around the world, governments have stepped in and provided a range of stimulus packages in order to safeguard people’s jobs, homes, and businesses. These measures should provide a solid underpinning to the key elements within society, which we believe will allow the bulk of society and the economy to resume as normal when the impact of this pandemic has eased.
These measures should mean that consumer demand and economic activity should return to normal levels very quickly. In addition to this, there is also a widespread expectation that there will be an additional wave of pent-up demand. Large numbers of people have been forced to stay at home and forgo many luxuries and we expect to see a spike in demand.
It should be noted that predicting financial markets and economies is difficult at the best of times let alone in the midst of a global pandemic. However, history has shown us that however dark and bleak a crisis may appear conditions do recover. Market conditions have the strong potential to bounce back sharply due to the above-cited factors.
Consequently, we see the current scenario as being a period of investment opportunity for those with the liquidity and bravery to invest during a difficult period.
It should also be noted that any investment should be treated as a medium to long term holding and should only be undertaken with funds that you are unlikely to need over the short term. Additionally, the high level of market volatility and the prospect of further drops can make trying to time investments inherently difficult. In many cases, we are advocating a process of gradual investment over a period of several weeks or months so that investors benefit from pound cost averaging of their investment capital into a volatile or potentially falling market.
To further discuss potential investment opportunities and the best way to utilise capital during this period of potential opportunity please contact Foresight Wealth Strategists to discuss your individual requirements in greater detail.
Having the confidence to make bold investment decisions, when others around you may be panicking, can be very difficult, but at times like this it is important to remember the famous saying by Lord Rothschild who said that “the time to buy is when there is blood in the streets.”