Ravenscroft Group | Kevin Boscher
24 Mar 20
Some signs of light at the end of the tunnel?
After a tumultuous few weeks, we are starting to get a little more clarity about the likely path of coronavirus and its impact on the global economy and financial markets. Although the Covid-19 pandemic is expanding rapidly, the spread of the disease appears to be moving along a well-defined “curve” once the authorities take drastic measures.
It seems to have peaked in much of Asia, although new cases are still emerging from people entering the countries, and much of East Asia is aiming to return to more normal economic activity during April. Whilst Europe is considerably behind this timeframe, there are tentative signs that the rate of acceleration of the virus is slowing, especially where the authorities have acted swiftly to lock down social interaction and where good healthcare systems exist. The US remains the wild card as the Trump government has been slow to react, the data is unreliable and the private healthcare system brings additional problems.
The meltdown in risk assets over recent weeks has been brutal and fast, prompting an aggressive response from global policymakers. Whilst the declines experienced in equity markets have not yet been as severe as in the 2008/09 Great Financial Crisis (GFC), the monetary and fiscal stimulus announced so far has been just as dramatic and has occurred relatively early into the shock.
This week, the Fed announced a substantial array of new monetary measures to support the financial system and the US economy. It will expand its Quantitative Easing (QE) on an open-ended basis and will include purchases of investment grade corporate bonds and bond ETFs as well as Treasury securities and mortgage-backed securities as part of the programme. The Fed will also collaborate with the Treasury to establish a range of new credit facilities in order to support up to $300bn of new financing to firms and households.
These measures are designed to ensure that the business sector can continue to function and exist even as economic activity temporarily collapses as a result of the coronavirus lockdown. They should also help to ease financial conditions in the credit markets and will help support the huge package of direct assistance and loans being prepared by Congress. The Fed is also coordinating with other global central banks to make sure that the shortage of US dollar liquidity outside of the US, which is causing significant problems for dollar debtors, is addressed. The Fed is now effectively the direct lender of last resort to both the real economy and the financial system and not just in the US.
In the UK, the Bank of England has also cut interest rates to a record low 0.1% and boosted its QE target by £200billion to a total of £645billion. The increased amount will be used to buy additional gilts, which will be required to fund the government’s fiscal spending, but will also include corporate bonds. At the same time, the government has announced a package of measures to support businesses and individuals. These include an unprecedented commitment to pay up to 80% of the wages of employees at risk of losing their jobs in addition to pledging a further £330 billion in loan guarantees and promising more help for self-employed workers.
This latest action, together with other recent and equally aggressive policy announcements are evidence that global policy makers are committed to doing “whatever it takes” to limit the economic shock from the coronavirus outbreak and to prevent the pending recession turning into a more serious and longer duration event. They are also determined to ensure that the markets remain liquid and functioning, as many businesses as possible stay solvent and any rise in unemployment is temporary.
The cause of the current economic and financial malaise is very different than in the past. The underlying catalyst is unique in being a pandemic health shock which has evolved into a series of energy, economic and financial crises. The duration and full impact of all of these problems remains unclear and fluid. However, the consequences, although extremely serious, are very likely to be temporary, as in previous similar periods (most notably 9/11 and 2008 GFC) and will be moderated by forceful and prompt policy easing. Assuming this is the case, then we can look forward to a substantial recovery in economic activity in the not-too-distant future as fear and emotion subside and as the stimulus takes hold. This should also drive a significant rally in financial markets and equities, in particular, given that selling has been indiscriminate, investor sentiment is extremely pessimistic, valuations are much more attractive and liquidity is flooding the system.
We will likely need confirmation that the health crisis has peaked and the policy actions have been effective before gaining conviction that the global economy and financial markets have “turned the corner”. Investors still face considerable uncertainty regarding three key risks; the spread of the virus, will the stimulus work and will credit markets seize up? Also, some things will likely be different longer-term as a result of this shock. For example, interest rates near zero and expansionary fiscal policies for a prolonged period of time will almost certainly lead to higher inflation in the years to come. Gold, real assets and companies with strong balance sheets and pricing power should do well in this environment. In addition, companies, governments and individuals will need to invest more in healthcare and technology, whilst superior growth rates and rising income levels should favour emerging over developed markets, especially in Asia.
It is impossible to time markets consistently, especially when fear and emotion are the key drivers, such as now. However, what we can learn from previous crises is that things will recover, probably sooner and more quickly than most people expect and some very attractive investment opportunities are appearing for long-term investors.
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