It is a week since my last communication, and what an extraordinary week it has been! Having dealt last night with a distraught 16 year-old daughter worried about the cancellation of her GCSEs, I awoke this morning to prepare my SW London flat for close down (in a borough listed 3rd in the country for the number of COVID-19 cases per head of population!), and pack my bags for an extended potential exile in the country. Leaving the flat, I avoided the potentially infected handlebars of my usual Boris bike and walked instead past vans of police to an Oxford Street devoid of pedestrians. Entering M&S, where the staff outnumbered the shoppers, I looked again at the empty shelves hoping to buy sanitizer and tissues with no luck and arrived at the office for a brief check-over, switch our Bloomberg terminal to remote working mode and host our morning markets call via a video conference app, before returning to work from home. This weekend I will no doubt become an IT expert again as I grapple with my children’s laptops to set them up for remote schooling. How life has changed!
Whilst we all deal with the impacts on our daily lives, the corporate and investment worlds too are trying to adjust, both to the immediate impacts and to the longer term implications.
In times where the outlook is hugely uncertain, firms and people alike, attempt to build up their war chests of cash to tide them through the period they believe that uncertainty will persist. Corporates are cutting every expense that is not nailed down, consumers will avoid big ticket items and gross exposure is being cut via deleveraging debt from whatever liquid assets can be sold. Sales have not been restricted to equities. Indeed US Treasuries, usually seen as a safe repository for capital in times of stress, have also been sold to raise cash, in part to service the huge amount of dollar debt that has been built up on cheap rates since 2008. The recent volatility, falls in bond prices and demand for cash demonstrate that a liquidity crunch is occurring to which the central banks are responding with huge capital injections; the European Central Bank and Bank of England being the most recent to respond with their EUR 750 billion and GBP 645 billion bond buying packages, ensuring some reprieve for European bond prices.
The increase in dollar demand is contributing to large relative differentials in the currency markets. The dollar’s rise perhaps reflects the unique role this currency continues to play in the global economy and financial system as dominant ‘safety’ cash. It may also reflect its role as principal trading currency across industrial supply chains throughout Asia and the emerging markets, where payment disruption along those chains leads to worries that dollars might not reach the critical non-bank intermediaries that handle the financing. Thus, further liquidity is required here too.
The dollar has strengthened considerably against sterling, in a mirror image of the 2008/09 financial crisis, which has helped soften the blow slightly for UK investors, with the pound now trading at a near 40 year low vs the dollar. Interestingly, the euro has been quite stable against the pound, which commentators are suggesting could be due to Britain delinking from the continent.
Whilst the cash and bond markets reflect the very short-term needs of building financial resilience through the forthcoming economic disruption, the equity markets, which have already suffered significant sell-offs (continued this week), are perhaps now beginning to adjust for what can be determined about the future.
How deep and how long will the recession be? What industries will be permanently damaged and never recover? Which industries will suffer a slow recovery and which businesses might prosper under a ‘new normal’? Of course, so much depends on government (dictats and fiscal) and central bank (monetary stimulus) interventionist response from which there will be winners and losers, thus making investors decision making fraught with imponderables. Whilst since 2008, banks are better funded, and the central banks well practiced in oiling the wheels of the financial system, they won’t solve the real economy’s solvency problem. For that, fiscal giveaways are required in the form of direct cash payments (helicopter money), consumer assistance (e.g. mortgage and rent holidays and enhanced benefits, particularly for those suddenly unemployed), corporate tax breaks (e.g. business rate holidays) and more. Even with the most generous government action, corporate earnings will be badly hit this year by such a colossal, albeit hopefully temporary, disruption to supply and demand of goods and services.
Markets are certainly pricing in a severe recession. As discussed above, the economic shock is being compounded by the unwinding of leverage and a liquidity shock. The good news is that valuations reflect the sharp deterioration in global growth and appear to have overshot in many areas. But the bad news is that the size and duration of the unwinds may take much longer, given the proliferation of leveraged strategies over the past ten years of quantitative easing; so we should expect continued market unpredictability for at least a couple more weeks for this reason alone, regardless of the trajectory of COVID-19 cases.
In conclusion, this volatility will continue until we see some sign that COVID-19 cases are peaking which will only occur through the containment measures being put in place and perhaps as the Northern Hemisphere cold and flu season ends. Only then can the restrictions impacting businesses ability to operate (e.g. the movement and engagement of workers and customers) be lifted and human mindsets return to rebuilding our way out of the mess created. Nevertheless, charts show a tailing off in the pace of the downward movement of equities which might suggest that, with no new negative news, a bottom may broadly have been reached. We continue to monitor the situation and make adjustments to rebalance and position portfolios for a recovery.