14 March, 2020

Coronavirus & The Markets: How GFC Memories are influencing today’s reality

After 12 years of relative calm, investors are faced with new challenges due to the uncertainty COVID-19 is causing around the world, and the unknown implications. This volatility dominating headlines and creating events not seen since 2008, reminds us of the two simple rules you learn on your first day in finance:

  1. Be long term focused; and
  2. It’s not the return ON your capital that fundamentally matters, it’s the return OF your capital that is what builds wealth. 

With markets moving five to seven percent per day and the measure of global volatility touching levels not seen since 2008, investors are comparing this with the depths of GFC. For investors, maintaining perspective, understanding risk tolerances and getting advice is what will help determine if there are opportunities that suit their risk profile.

23 days ago, the world started to see the impact a global pandemic has on consumer behaviour and confidence, and this week we have seen second-round impacts - an oil price war and poorly executed leadership. It is these impacts which have dislocated markets globally. COVID-19 caused a very sharp reduction in the demand for oil, prompting OPEC members to discuss a cut in production. As it transpired, two of the most reliant oil nations (who need to sell oil to fund their countries) couldn’t agree on reduction cuts so instead entered a price war. This removed any sense of stability in the global economy, triggering passive fund selling around the world. Some reports suggest that markets were seeing sell orders from ETF/Futures on a 9 to 1 ratio at their peaks. This caused volumes to exceed what the market can handle at any given time, dislocating prices globally. The world followed with promises of fiscal stimulus and borders being shut down almost at random.

This is not the first time we have seen this type of volatility and in fact, because the last example is fresh on people’s minds, we are faced with the problem of heuristics. 

That’s a fancy word that means, as humans, we compare facts to our own experiences rather than build a unique set of possibilities based on the facts. For example, if you were asked to draw a planet, most people would draw some sort of circle or oval shape as we have never seen a square shaped planet. Whether it’s possible or not does not enter our minds. 

Why this matters is our reactions to COVID-19 and an oil price war will now mirror what we saw during the GFC as that is what people remember, whether or not the economic reality of that mirrors the economic reality of today’s situation. In 2008, wild volatility, panic and fear were prevalent because, at the time, people were in fear for their jobs and homes, banks were facing runs on cash, and there were concerns many banks would fold. Interest rates had been going up for years, oil had increased from US$60 to US$70 per barrel, and debt levels were high. 

In 2008, the market took nearly six months to start to factor in the stress in the mortgage market. Bear Stearns was bailed out in March 2008 and the market didn’t really fall until September (over a year post stress being evident) when it fell 30 percent in the space of 90 days, and the governments intervened in October 2008.

Today we have seen a nearly 30 percent move in 23 days and are seeing the same comparisons and dislocations to capital markets being made well before the true nature of the economic impact of the virus has been realised. The environment we have today is record low interest rates, a falling oil price and generally healthy corporate balance sheets, but instead of markets reacting to economic data, we have markets predicting an economic outcome approaching the first phase of the GFC.

Compare that to 2008, where from the peak pre-GFC to its very lowest point the index broadly fell 40 percent, and since has rallied 400 percent, so leaning into the wind comes with risk and rewards.

There are two fundamental differences between today and GFC

First, the speed of the move: In 2008 the markets followed the economic reality rather than led it, and governments acted slowly. Today we have the markets falling before we know the extent of the data, and central banks and governments are acting very quickly, at times acting before thinking.

Second, the causation: In 2008 it was the financial system that was stressed because of poor loans in the mortgage market, leading to economic stress and bank bail outs. Central banks could directly intervene into the causation, being the financial system.

In 2020, it is the economic system that is stressed because demand has dried up for many industries, this requires targeted fiscal intervention. Central banks can assist liquidity but they can’t directly get to the consumer.

Therefore, the environment today is very different to the GFC (in both good and bad ways) and requires us to step back and consider our reaction, because no one has the perfect answer and markets generally misprice risk. 

The market is expecting we face some sort of recession now, with the uncertainty being will it be one quarter or more, and the question that is being asked is which stocks have priced that in already and which ones have not.   

The impact on the tourism and hospitality sectors has had immediate impacts and have been immediately re-priced, whether rightly or wrongly. It’s the duration of COVID-19 and government fiscal packages which will determine whether they have been correctly priced by the market.

As we see risks today, it is the businesses that have been impacted by the supply chain disruption to the transport sector, retailers, exporters and manufacturers that the market doesn’t have enough facts on to form a well-informed view, yet have fallen to the same or more degree. Companies always adapt, some exporters will have to start looking at alternative markets for some of the more at-risk produce going into China, some will benefit from domestic spending, and some will see no meaningful long term impact to their earnings at all.

Supply chain impacted industries will likely have sufficient inventory in the system to get through for a period, but there will be limits before further disruption negatively impacts them. Our assessment of guidance from New Zealand listed companies to date would suggest further updates will be needed for those companies most impacted if the virus’ impact extends well into the second quarter of 2020. 

Because of this uncertainty in the next six months’ earnings, investors have reverted to memories of GFC, where we had the same environment of markets being driven by headlines and today those movements are made larger by passive investing.

When we look for the potential circuit breakers to this cycle they fall broadly into two buckets: containing and treating COVID-19, and Government intervention.

Containing and treating COVID-19

While COVID-19 is a global concern, we can look at the aggressive approach China, Singapore, Hong Kong and Japan took to demonstrate the art of the possible in containing the outbreak. According to the World Health Organisation, the number of new cases this week combined for China, Singapore, Hong Kong and Japan is less than some European nations are finding in a day. While many were sceptical of the Chinese numbers to begin with, other countries are showing similar patterns to Asia.

If China continues to contain COVID-19, then we would expect to see a sharp rebound in manufacturing and agriculture demand and investors would be looking for a recovery in stocks, but there are a number of issues to consider:

  • If Europe fails to contain COVID-19 then markets will continue to be disrupted, impacting tourism and travel related companies and countries for some time to come, with the flow on impact being SMEs will suffer - leading to weaker general economic activity and slower employment. 
  • As we move into a Northern Hemisphere summer, will that contain COVID-19 in Europe, North America and China? How will the flu survive in 30 degree plus heat?
  • Will the recent phase 3 clinical trials being run by Gilead in Wuhan prove to be effective? The results are due in May but will news of these results make their way into the public domain earlier?
  • Will the US have a serious outbreak and how will Trump handle that?
  • If we see a rebound in global growth, will oil recover?

So the direction of COVID-19 in the coming weeks will help determine the direction of the market, and once you combine that with the likely responses from Central Banks and Governments we can form a view.

Government intervention

In March 2008, we began to see the economic impact hit markets, with Bear Stearns being taken over by JP Morgan at the request of the Federal Reserve. But it wasn’t until October 2008 that we saw the bank bailout plans around the world take place, by which stage the damage had been done with 2.6 million US workers having lost their jobs in 2008.

The world since then has learned that government and central bank intervention is best done in “co-ordinated” force, so in 2020 we have seen emergency cuts within two weeks from Australia and the US, and governments announce fiscal aid and possible tax breaks. In New Zealand, Reserve Bank Governor Adrian Orr has vowed to do whatever the central bank believes is needed and Prime Minister Ardern is considering fiscal assistance. These measures of stability will take time to flow through the system, but they will result in interest rates being lower for longer and a stimulus led recovery.

Thursday’s fall in markets highlighted the importance of swift leadership with formulated plans, not partly considered views. Prime Minister Ardern showed strength last year in her actions and the boldness of her fiscal response to COVID-19 will likely be a determining factor in the election this year.

Taking this all into consideration, if COVID-19 is a short-term phenomenon (largely over by European summer) then this market sell-off will, with hindsight, have created some opportunities to rebalance portfolios for those investors willing to venture in through the middle of it. 

Concerns are likely to continue over the next few weeks and further volatility in share prices should be expected, so it will always remain important for investors to understand their own risk appetite and seek advice. This period in markets is likely to be difficult with opportunities presenting themselves on some bad days, no one is immune to the emotional triggers of a volatile market and many new investors may not have been involved in capital markets in 2008 so shouldn’t be afraid to ask for help.

Focusing on quality companies with solid balance sheets that can withstand the short-term earnings shocks – in some cases, with the support of the banks – will provide investors opportunities from the re-rating that generally occurs once confidence returns, but in this environment it is unlikely to be as simple as buying randomly or buying everything.

James Lee is CEO of corporate finance & markets firm Jarden. With 20 years’ capital markets experience he is involved in all Jarden’s equity capital transactions from IPOs to secondary sell downs, mixed ownership models and bespoke capital solutions. James leads the firm’s relationships with corporate and institutional clients across Australasia. James was a member of the steering committee for Capital Markets 2029, and the investment committee for Cystic Fibrosis New Zealand.

A version of this article was published on the New Zealand Herald on 14 March 2020. 

This article reflects the opinions and views at the time of publication, and is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision. Jarden is an NZX Firm, a broker disclosure statement is available free of charge at www.jarden.co.nz. Jarden is not a registered bank in New Zealand.

All media enquiries, please contact:

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