The first three months of 2020 were the worst for global markets since the 2008 financial crisis as a result of the coronavirus pandemic. Indeed, the 11-year old bull market ended abruptly as the US market suffered its quickest descent into a bear market in just 16 trading sessions. Markets have been beset with fear as governments have struggled to deal with the health crisis and life has been brought to an abrupt halt around the world with citizens locked down at home and subject to strict social distancing rules. In addition to worries about the pandemic, markets have been stressed by the consequent impact and extent of a global recession and the effects of a plunging oil price.
The market pain in the middle of March was particularly acute with major market indices dropping by 10% each day. Trading and short-selling had to be halted in some markets to help prevent panic. Liquidity was put under immense strain in many financial assets, with large parts of the corporate bond market untradeable and direct property funds closed. It was in many ways reminiscent of the dark days of the financial crisis of 2008. Market falls were accompanied with a flight to safety in US dollars, a rally in secure government bonds, as households hoarded pasta and loo roll. Gold, often associated with being the ultimate safe haven, provided little protection, itself a victim of dollar strength and market turbulence, overall barely unchanged over the first three months of the year.
The oil price also collapsed in the first quarter of 2020, falling from $70 a barrel to just $20, increasing the overall turbulence in financial markets. This fall was due to both oversupply and a slump in demand as the world has been locked down with coronavirus. The oversupply has arisen following a disagreement between Saudi Arabia and Russia, where both countries refused to cut production resulting in a price war. The political dimension is that neither Saudi Arabia nor Russia want the US to acquire market share as it ramps up production of shale oil. The cost of production of shale is much higher than conventional wells, so a fall in the oil price makes US shale mostly uneconomic.
Currencies have also been volatile during the first quarter of 2020. Sterling suffered a big drop against the perceived safe haven of the US dollar to just 1.15 in mid-March, before recovering to 1.24 at the end of March. Sterling has also lost ground against the euro and Yen overall, finishing the quarter at just 1.13 and 133 respectively. Sterling weakness has at least benefited UK investors with a tail-wind for most of the period in respect of overseas investments.
However, financial markets rebounded strongly at the end of March following massive stimulus packages announced by many governments and central banks around the world. Apart from the £350 billion support for business in the UK, most noteworthy was the €750 billion support from the European Central Bank and $2.2 trillion fiscal bazooka unleashed by the US, which ranks as one of the largest ever economic interventions. Indeed, the rally on Wall Street was the strongest rebound since the financial crash of 1929. The financial firepower aimed to prevent the health crisis becoming a financial Armageddon. Specific measures involved aiming to shield businesses and households from insolvency by buying financial assets in huge quantities (effectively another round of Quantitative Easing), injecting massive liquidity into financial markets to prevent markets becoming choked and reducing the hoarding of US dollars by supporting other currencies. Central banks also played their part, cutting interest rates to almost zero in many countries, including the UK at 0.1%.
The outlook for the next quarter remains uncertain as the coronavirus crisis worsens in the US with President Trump warning of a ‘very, very painful two weeks’ and possibly approaching 250,000 deaths. However, there are some tentative early signs of an improvement in respect of Covid-19 in Italy and Spain, which may now have reached the peak in new infections. Nevertheless, there remains the risk of re-infection, a worry which is apparent in both Japan and China.
The economic cost and fallout from the global health crisis cannot be accurately modelled at this stage. It is clear the eventual cost will be enormous for societies around the world. This is likely to test social cohesion, as well as result in higher taxes for years to come acting as a brake on economic growth. Already, US unemployment has increased to a historic high of 3 million, a statistic which is likely to deteriorate and be mirrored by large scale redundancies in other countries.
An economic recession is inevitable in most countries this year as business activity contracts. In the UK, this adds an additional challenge for the government to address and is likely to require a further delay to negotiating the future relationship of the UK with the EU post-Brexit.
The pressure on banks has been revealed in the UK as the regulators have forced dividends to be scrapped, so as to shore up their capital position. Dividend payouts from companies in other sectors particularly hard hit by the crisis are also likely to be cut or scrapped, such as travel, leisure, retail and oil.
Purchasing Managers’ indices (PMI) are typically used as a gauge of the health of the global economy. The latest Asian PMI numbers are low reflecting a very difficult outlook for manufacturing. This is unsurprising as many countries remain in lockdown with most businesses either closed or operating at a significantly reduced level.
On the positive side, governments and central banks are committed to providing financial support and stimulus to keep the wheels of the global economy turning. There are discussions regarding a common EU fund to help Europe through the crisis and the new governor of the Bank of England, Andrew Bailey is in agreement with significant government borrowing to fund infrastructure projects. This should help mitigate some of the worst effects of the severe reduction in economic activity. Indeed, the pledge by the US Federal Reserve to support the US economy echoes the promise by Mario Draghi of the European Central Bank after the banking crisis of 2008 to ‘do whatever it takes’. Draghi’s commitment is now regarded as a key turning point for the market recovery.
However, ultimately, this is a health crisis and not a financial crisis. So, markets are watching anxiously for signs that the spread of Covid-19 is slowing, as well as the possibility of testing and certification of immunity, so individuals can get back to work. Talk of a vaccine is encouraging, but the timescales for development, testing and mass roll-out are still several months away rather than weeks.
In the short-term, the best investment strategy in our view is to maintain a steady approach as it is too late to sell as markets have retreated too far, but it is too early to buy with confidence as markets continue to grapple with the risks of a shrinking global economy and a collapse in the price of oil. Certainly, President Trump was premature when he took to social media to encourage Americans to buy stocks in late February when the US market was 20% higher than today.
Even today, some commentators who are claiming a generational buying opportunity beckons with a ‘V’ shaped rebound appear too optimistic considering the global economic forecasts and indicators. A slower paced ‘U’ shaped recovery appears to us more likely at this stage, as it will take time for demand to return and for fractured supply chains to be rebuilt, companies to re-hire, re-skill and re-stock inventories.
However, as the severe market falls have resulted in a high level of fear, this does present us with an increasing number of potentially attractive investment opportunities, being mindful of the old adage ‘buy on fear and sell on greed’. In respect of asset classes, cash and bonds with interest yields of 1% or less do not look attractive to us as long-term investments, even allowing for the potential risk of recessionary deflation or Japanese-style low inflation and anaemic growth. Indeed, equities remain the favoured asset class for us with the possibility for investors of re-growing both capital and dividends over time.
Of course, it is almost impossible without the benefit of hindsight correctly to call the bottom of the market, but it is apparent that many valuations are starting to look appealing on a medium-term basis. As such, the best approach is likely to be achieved by selectively phasing cash into the markets over the coming months with the aim of buying on dips and profiting from the continuing market volatility. Companies with strong balance sheets and plenty of cash, as well as robust business models engaged in providing essential services are likely to be most attractive for investors over the coming months.
Looking ahead once coronavirus has been brought under control, markets require stability. This will require political initiatives around the world to re-build and extend global co-operation, particularly between the US and China. This is vital to avert a prolonged recession and ensure growth returns, so private and public debt can be serviced and plans developed to repay debt, so future generations are not excessively encumbered. Accordingly, the focus of governments will need to include increasing and supporting global trade, addressing social inequality so wealth increases across populations and dealing with the threat of climate change. Our investment approach will remain flexible to ensure it reflects how the world responds to these multiple and complex challenges ahead.
Please note, our Market Overview & Outlook is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. Overseas investments are affected by currency movements and exchange rates. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.