What happens from here?

March 2020 has witnessed capital markets display quite extraordinary dynamics. In this past four weeks, we have experienced both bear market conditions with falls of in excess of 20% and bull market conditions with stock gains of over 20% in 3 successive days last week. The S&P 500 grew by 13.59% overall last week, while the FTSE 100 lifted by 12% after some end of week reversals. This rapid rebound highlight that recovery can be unexpected, swift and easily missed.

The reason that we saw such an uplift in equity values last week was due to a monumental and co-ordinated fight back from the leaders of the G20 group of the world’s wealthiest countries. Collectively they pledged US$5tn to support the global economy in overcoming the impact of the Coronavirus.

The largest stimulus came from the US Federal Reserve. The Fed delivered a US$2bn package of measures and now sits on a balance sheet of US$5.5tn. These latest announcements come on top of interest rate cuts to near zero and the re-starting of a US$700bn quantitative easing programme. In Europe, Germany launched a stimulus package worth 4% of its GDP and guaranteed loans of €822bn and a further €600bn economic stabilisation fund. These actions were proportionately matched by other G20 members.

Markets responded with significant rallies and latter some pull backs as analysts and traders came to terms with the implications of the biggest monetary stimulus in human history. We are now in a position whereby central banks are underwriting the financial system while governments are now underwriting the real economy.
The action may now have allowed global stock markets to find a floor and avoid a depression. Volatility will still continue as markets are uncertain and lacking direction. While there is undoubtable value in a -35% fall in markets, no positive trend has yet to emerge. The end of the week falls has been put down to profit taking after the weeks earlier gains.

It is still unlikely that both equity and credit markets will truly stabilise for some time. There have been dangerous strains on credit markets as investors dumped assets of all kinds in favour of the US$. As part of their stimulus package, The Fed purchased US treasuries, mortgage backed securities and investment grade corporate bonds in order to weaken the US$ and halt the global rush to US$.

We are now one week into the UK lockdown and as time goes by the judgements over the impact on public health and our economy will be easier to make. If the shut down goes on for 3 months, we should be able to emerge operationally intact due to the government support for business, wages and the self-employed. The economy could bounce back as latent demand may create a mini boom. However, if the lockdown goes on for as long as six months, the less able we will be to swiftly recover as our preparedness and ability will have deteriorated. Yesterday the deputy chief medical officer for England Dr Jenny Harries OBE said she felt the lockdown could last between 2 and 6 months.

It is important that the government should be clear about their expected lockdown period in order for business to plan. Keeping the nation in lockdown in order to allow time for the NHS to build up to maximum capacity and in doing so cope with the unprecedented demands is vital for our public heath and survival rates but a prolonged lockdown will hit our national, corporate and household finances with longer-term implications.

The Centre for Economic and Business Research (CEBR) is predicting that the UK will see a rise in unemployment of 1 million people within 4 weeks despite the emergency support. This forecast is being eased by the number of sectors seeking to take on new staff as different demands develop in the new economy. Concerns over levels of unemployment grew after 3.3 million US citizens registered for unemployment benefits last week. Economists at J P Morgan have suggested UK jobless figures will hit 8% up from the current 3.9%.

We are very concerned about the damage done to client’s investment portfolios and pension funds even though this may prove temporary. People will be now wanting to know have we hit the bottom and what happens from here? Investors will not want to miss out on gains if shares rebound sharply.

There are some indicators that can be useful to watch, these are commodity prices that are sensitive to global demand. The two most relevant ones are copper and oil. If these two key commodities find a floor it would give an indication that the market is past the worst. Oil has seen heavy falls in value in recent weeks due to the fall out of the OPEC / Russia protocol over supply levels. This has distorted prices. Brent crude oil prices have stabilised at around US$25pb since 18th March. The London Metals Exchange priced a tonne of copper at US$5750 in late February and now stands at US$4775. This value seems to have also stabilised as production is starting to recover in China. We shall keep monitoring the prices of both.

The other key indicator is the levels of Coronavirus contamination and death levels in Europe and USA. As we are yet to hit peak impact, we cannot be sure of the eventual numbers. But when levels are falling markets will see that the worse is past and react positively.

I have been researching the views of analyst and economic forecasters over the likely style and outcome of the pending recession. There seems to been a majority view that the world will either face a V-shape or a U-shaped recession with some suggesting a longer flatter U shape recession. Opinion is split between the first two scenarios with a V-shape having at this stage greater support. Far less are predicting an elongated U-shape due to the massive financial stimulus just announced and that this stimulus will be added to if proved insufficient.

A V-shape recession will be one where Covid 19 is contained and peaks within 2 months, that central bank liquidity is sufficient and China rebuilds its inventory and supply chains to recover in Q2 while Europe and US take longer to pick up but do so over Q3 and Q4. Output recovers to the point in Q2 2021 when we are back to normal and global inflation remains low. Equity markets bounce back in Q2 ahead of economic recovery as the long-term impact of Coronavirus is not lasting.
A U-shape recession will be one where Covid 19 is contained but takes longer and that further central bank intervention is needed. The Fed will need to support the ongoing demand for cash which could create a liquidity squeeze in credit markets. Pressure will build on heavily leveraged business and credit vulnerabilities are exposed particularly in the US. We would expect the Fed to protect the credit markets by further purchasing treasuries and investment grade bonds. With prolonged uncertainty equity and bond prices would fall further until a second wave of stimulus and intervention stabilise things. At that point there will be a pick up.

The remarkable swift way that Coronavirus has hit every aspect of human life leave analysts seeking to predict a future course of economic recovery at a great disadvantage. These are unprecedented times. This recession is utterly unique as it has been self-imposed and expected to be limited in nature.
Our overall view is that a more risk adverse approach is prudent at present until we get greater clarity and some form of trend established in commodity, equity and bond prices. If the worlds citizens fully comply with their government advice, we will get through this and the potential for a strong bounce back gets stronger.

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