The rapid downturn in fortunes on coronavirus and oil price fears, and concerns for the health of the global financial system, has left few risk-based assets unscathed. What next, asks Andrew Pitts.
Throwing a grenade into a bloodbath conjours visions of a gory scene from a Sam Peckinpah or Quentin Tarantino movie. But this was the apt analogy used by one financial analyst to describe Black Monday on 9 March. Global markets, having already executed one of the swiftest retreats since the Great Depression on Covid-19 fears – reacted violently to the oil price war launched by Saudi Arabia over the preceding weekend.
As the price for a barrel of Brent crude tanked by around 30%, stock markets reacted with falls on the day of up to 12% in emerging economies such as Brazil, and between 7% and 8% in the developed markets of Europe and North America. In doing so they slid from “correction” – defined as a fall of more than 10% from a 52-week peak – and into the territory of a fully-fledged bear market, which is a fall of 20% or more.
With stock markets having already been “priced for perfection” until mid-February, the global spread of the virus was the proverbial straw that broke the camel’s back, and the outbreak of the oil price war was the 16-ton weight dropped from a great height that flattened it.
Although the direction of markets was in the balance, no one was prepared for what came next. President Donald Trump’s sudden announcement of a 30-day flight ban from European Schengen area countries saw shares take another downward lurch. What proved to be the worst-ever day for shares in Europe was exacerbated by far-from-reassuring comments from new European Central Bank president Christine Lagarde and evidence that liquidity in the US Treasury bond market was drying up.
The FTSE 100 had its worst day since the other Black Monday in October 1987, down 10.9%, European stock indices lost up to 12% and the S&P 500 plummeted by 9.5%. At the end of a tumultuous session, “Red Thursday” 12 March was the worst day for markets globally since October 1987.
In just a few short weeks, the FTSE 100 has lost nearly a third of its value, the FTSE All-World index has fallen around 25% from its recent peak, and the US is now firmly entrenched in a bear market.
Now, the obvious questions to which everyone requires answers are: will markets fall further; and should I buy, hold or sell assets in my portfolio?
The quick answers to these questions are: investors have clearly capitulated and thrown in the towel, but we should expect further bouts of extreme volatility over the next few weeks; and secondly, to keep calm and carry on.
Although the latter is something of a cop-out answer, it is a strategy that makes sense for most private investors. Rarely should you sell into a falling market – unless you are over-exposed to an asset class for an inadequate timeframe; you already have a fairly large gain that you would prefer to crystallise; or suddenly find that you need access to cash. And if you are an investor in pension drawdown, it is extremely unwise, as the capital from which to draw income over the years will be significantly reduced and does not have the opportunity to bounce back when markets improve.
We do not yet know the full impact of the coronavirus epidemic on economic growth and the values of risk-based assets, from stocks to corporate bonds. A more coordinated global response from central banks and governments through monetary and fiscal measures will help restore confidence, but there is only so much that governments and central banks can do to limit the impact – on both supply and demand – of Covid-19.
Here in the UK, the 0.5% cut in interest rates by the Bank of England, back down to a historic low of 0.25%, will be of little help in this respect. However, the relaxation of capital adequacy rules for banks will encourage them to continue lending, helping to ensure that economic activity does not suffer unnecessarily. Chancellor Rishi Sunak’s announcement of a £12 billion coronavirus relief package in the Budget is welcome and necessary, but there remains much for other governments to do to limit the economic impact, particularly in the US and the eurozone.
Even after these seismic market moves, the intermediate outlook for investors remains highly uncertain. Restoring order to the US Treasury bond market may help to limit further falls. Some market strategists, however, think that a truly effective global response will mean adopting a chapter out of China and Japan’s playbook, with governments and central banks stepping into the markets to buy not just corporate bonds but equities as well.
Some investors had been tempted back into equity markets following the large, swift falls in valuations. But “Red Thursday” showed that catching a falling knife can leave you with extremely bloody hands. The morning of Friday 13th is providing some respite, but there have been some salutory lessons for those who could be minded to “buy the dip” again. The animal spirits that have helped drive equities ever-upwards for the past 11 years, spurred on by ever-accommodative central banks that are now rapidly running out of firepower, have been slain.
The implication is that investors at large will continue to favour the haven of lower-risk assets into the second half of the year. Government bonds, corporate bonds issued by large, financially secure companies, gold and cash are natural havens. Assets denominated in currencies such as yen and Swiss franc are also popular. This trend is set to persist at least until the number of new infections reported globally begins to decline, and probably also until oil finds a natural floor and begins to recover, which seems unlikely until well into the second half of the year.
Despite technical indicators suggesting, but not screaming, that equities are cheap at current levels (FTSE 100 at c. 5600, S&P 500 at c. 2600, Stoxx Euro 600 at c. 320) it is unlikely that we have seen the floor. Companies that have issued non-investment grade ‘junk’ bonds that need to be refinanced in the near future are most at risk. Small and medium-sized companies in general probably have further to fall, given the deteriorating global economic outlook. But companies that have sound balance sheets and decent returns on capital employed will be more resilient and bounce back faster.
That said, analysts at UBS caution that the Covid-19 pandemic will see the MSCI All Country World index (ACWI) ending the year down 21%, with emerging markets taking a bigger hit in the second and third quarters (and down 32% on the year). That forecast was made before the stress fractures in the financial system became more serious; if these are not addressed, the damage to wealth could be longer-lasting.
Investors may wish to consider some potential tinkering with portfolio mixes to dial down exposure to more risky areas such as smaller companies and emerging markets. But it is a bit late now to be contemplating major surgery without potential long-term damage to the portfolio’s health.
If there is one silver lining to this swift and violent retrenchment it is that well-run, actively managed investment funds and trusts should significantly outperform passive index-tracking equivalents over the medium term. There’s nothing quite like a rout in the markets for picking up a bargain as the herd stampedes for the exit. And there is no time like the present to justify the extra fees that investors must pay for the privilege of having money “managed” on their behalf.
In the meantime, private investors should largely keep their powder dry and leave the hard work to the professionals.