Friday, 20th of March 2020
“It is said that the darkest hour of the night comes just before the dawn.”
– Thomas Fuller
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There was no let-up in financial market volatility this week as governments around the world introduced draconian new measures to combat the spread of the coronavirus. From Argentina to Uzbekistan, many countries have simply chosen to seal themselves off from the outside world in an effort to stem the tide of infections. However, perhaps nowhere has the change in policy this week been more profound than in liberal Europe. The continent has fast become the epicentre of the global pandemic. Indeed, the daily tally of deaths from covid-19 is now far higher than at any time during the outbreak in China, and the dire conditions in Italy, which has been in lockdown since 10 March, resemble those at the very peak of the crisis in Hubei province (where the virus emerged late last year). Policy is having to adapt – and fast. Having initially criticised the blanket US ban on travel from the EU by non-Americans, on Tuesday the EU Commission President announced that the block would close its borders to (almost) all inbound travel by non-citizens for 30 days. At the member state level, ‘social distancing’ measures are now in place across the continent with cafes, restaurants, bars, theatres, parks, schools, and other recreational and public spaces forcibly closed in many cases. Some countries, including Germany, Denmark, Spain, Hungary, and Poland, have closed their borders to all foreigners regardless of whether they are EU citizens, while France has followed Italy in declaring a nationwide lockdown with strict enforcement of intrusive restrictions on free movement. Even in the UK, where the outbreak is less advanced than on the continent and the authorities are reluctant to adopt harsh measures too early, the government has now been forced to close schools. At the global level, there have been >10k deaths from the virus so far and, sadly, many thousands more are likely to die before this outbreak comes to an end.
The demand shock from business uncertainty and restrictive quarantines facing consumers is having a large negative impact on the global economy. Although we must wait for the end of March figures to count the cost of the coronavirus to Q1 GDP, the economic numbers out of China on Monday paint a grim picture and suggest that there will be real harm to the real economy in all countries suffering from a major outbreak today. In the first two months of the year, Chinese industrial production was down -13.5% YoY, retail sales fell -20.5% YoY, and fixed asset investment collapsed by a whopping -24.5%. This data, and the general sense that the authorities in Europe and elsewhere are failing to contain the virus, helped to drive the S&P 500 Index down -12.0% by the Monday close. This was the largest one-day slide in the benchmark US index since 1987, and several percentage points greater than the decline on Thursday last week. Meanwhile, the CBOE Volatility Index (or VIX), a well-known measure of US stock market volatility, hit an all-time high of 82.69 (i.e., higher than on any day during the 2008 Financial Crisis). Even the Donald was forced to admit that the US was headed for a recession, albeit because of the wicked ‘Chinese virus’. Come the autumn, an ugly economic backdrop could be a gamechanger for President Trump’s re-election prospects, particularly with the moderate Democrat Joe Biden likely to face him at the polls.
Although few sectors will escape the fallout from the coronavirus pandemic, some are likely to suffer much more than others. Airlines, in particular, look vulnerable to a sustained downturn. For example, British Airways owner IAG (which has seen its share price tank >50% this year) has been forced to reduce flight capacity by 75% through April and May, while Lufthansa has cut 95% of its flights in turn. Retail, also, is likely to suffer disproportionately from the outbreak as forced closures of high street outlets and reduced demand from frightened shoppers harm a sector that is already facing stiff competition from online alternatives. The energy industry is perhaps in the most precarious state today, however. The combination of depressed demand due to the coronavirus outbreak and increased supply after the collapse of the OPEC+ alliance two weeks ago (and Saudi Arabia’s subsequent decision to ramp up oil production massively) has pushed Brent and WTI to <$30 per barrel. In fact, WTI was close to $20 per barrel on Wednesday before the US President suggested that he would intervene in the dispute “when appropriate”. This led to a +23.8% rally of WTI on Thursday, which is the largest single day increase in its history (and shows how volatility is providing many opportunities to trade and invest). He also pledged to give financial aid to smaller shale-drillers (<5k employees) by buying up to $3bn in oil from them. Nevertheless, a wave of defaults in the next few months cannot be ruled out, particularly if there is no Saudi-Russia ceasefire. With 80% of US HY energy sector credits trading at distressed spreads, the market seems to agree.
Given the huge threat to the global economy from the coronavirus, the monetary and fiscal response will need to be equally massive to save jobs and livelihoods. This week we got a taste of just how big policy makers think it should be. After G7 leaders issued a joint statement on Monday in which they promised to do “whatever is necessary” to support growth, the IMF pledged its $1tn balance sheet to the effort. At a single-country level, and crucially for the market, the US is soon likely to approve a Republican Senate bill that proposes a $1.2tn fiscal stimulus. The package includes sending a series of cheques worth >$1000 in total to all Americans (so-called ‘helicopter money’), $300bn in loans for small businesses, and $200bn in stabilisation funds. The balance will be made up from individual and corporate tax deferrals. On the monetary side, the Fed cut its policy rate by 100bps to a range of 0.00-0.25% on Monday and restarted QE with plans to buy at least $500bn in treasuries and $200bn in agency MBS in the coming weeks and months. The US central bank also established a Commercial Paper Funding Facility (CPFF) to ease strain in the short-term funding market which has emerged given the rush to raise cash and hold dollars (something which is driving the greenback higher at a ferocious speed). That the Fed felt that it could not wait two days until the regular FOMC meeting on Wednesday to announce these measures speaks volumes about the risks facing the global economy. In Europe, several countries have introduced fiscal packages worth many hundreds of billions of dollars. The UK government, for example, announced a £350bn package this week, including £330bn in business loans for struggling companies (this figure is equivalent to 15% of UK GDP). They did this in coordination with the BoE, which re-started QE and cut its benchmark lending rate to 0.1% (which is the lowest it has been since the bank was founded in 1694). However, of the many announcements out of Europe this week, the most important from the perspective of the market came from the ECB, which unveiled a new QE program worth EUR 750bn. The so-called Pandemic Emergency Purchase Program (PEPP) will run at least until the end of 2020 and should boost asset prices.
Once the present period of extreme volatility comes to an end, the injection of liquidity this week will be a major tailwind for markets. The sell-off has been so vicious and indiscriminate that there are no doubt interesting opportunities for investors with a long enough time horizon. Nevertheless, we do not expect a sudden turnaround for the economy because central banks have upped their game, and there remains too much uncertainty about how long quarantine restrictions will last to call the bottom for this market. There will come a time when this sell-off transforms the investment landscape and provides some of the most interesting opportunities since 2008. Patience is a virtue.
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