Views on COVID-19 – mounting concerns around credit triggered a cascade of indiscriminate selling in equity markets


Seema Shah

“Investors began 2020 with high hopes for strengthening global growth, but soon expectations for returns were dashed by overextended valuations and pockets of geopolitical risk. They began to re-evaluate risk, preparing for elevated volatility and lower returns.

In early February, worries quickly turned to COVID-19, and a vicious circle began forming on March 12, 2020. Investors scrambled for liquidity, powering higher volatility, spiralling liquidity ever lower. The record long bull market ended with the S&P 500 dropping 9.5% in a single session, its largest one-day move since1987. Enter the bear, arriving at the fastest pace recorded in more than three decades.”

What next?

“While policymakers can’t stop the spread of coronavirus, they still have an important role to play. The action from the Fed on March 12 and March 15 were less economic stimulus, and more an injection of liquidity to prevent capital markets from shutting down on themselves. The Fed’s intent was to prevent a supply shock via coronavirus from mutating into an illiquidity shock that could ultimately evolve into an insolvency shock.

“Comparisons to the GFC are inevitable, but that there are many clear differences. The GFC took 429 business days to play out, while the current shock has only been in motion for 24 business days. Could it extend itself to a multi-year drawdown? While the GFC was driven by an unravelling of significant imbalances which typically tends to be drawn-out, this current market selloff has been primarily triggered by the spread of coronavirus.

“Although a potentially devastating pandemic, the shock is likely only temporary. Once daily infection rates have peaked, financial markets will benefit from aggressively easy monetary conditions, sizable fiscal stimulus, low oil prices, pent-up demand, and cheap valuations.”

Investors are out of practice with recessions, leading to recency bias

“It’s been a remarkably long, profitable run since the global financial crisis. Investors have been infected with recency bias—the misguided tendency to weight recent events more heavily than distant events. This is due to the intoxicating yet troubling elixir of 1) easy access to capital, 2) predictably northward-marching risk asset prices, and 3) predictably underperforming volatility estimates.

“This meant that investors were largely unprepared for the economic chaos and market mayhem. The -9.9% total return in the Dow Jones on March 12—the fifth largest daily loss on record—may have finally brought cold, rational, investor sobriety to the forefront.”

Outlook – when will the bleeding stop?

“We believe global markets begin to recover when investors expect an improving COVID-19 situation hallmarked by reduced infections and manageable demands for health care resources.”

“While we initially expected to potentially see stability in the markets through any combination of coordinated Central Bank monetary response, an announcement of fiscal stimulus, or a firming in high-frequency Asian economic data; we’ve seen all of this and it has yet to give a floor to investors and their risk appetite.

Higher cross asset volatility forces some investors to reduce risk

“While the latest wave of worry is understandably concerning, closely tracking the indicators helps us understand what is happening through the market volatility, enabling us to capture opportunities as we ride out this crisis.

“Higher volatility forces some risk-conscious investors to reduce risk (margin funded, risk parity, systematic investors, etc.) Recently, that index has pierced the levels of the Euro-area crisis and the oil bust of 2016. It has a mean reverting feature, especially after sudden spikes.”

What we learn from earnings revisions and the Global Purchasing Manager Index (PMI)

“Many companies have suspended guidance due to COVID-19 and, in turn, analysts are struggling to estimate true earnings for the year.”

“At the start of the year, MSCI All-Country World Index EPS growth was expected to be 10% in $ terms –it was revised lower in February to 8% and we expect further downward revisions. It’s possible that 2020 EPS growth ends up getting cut to zero or even negative territory.”

“Nascent signs of recovery were nipped in the bud in March with a disastrous release in Chinese manufacturing PMI (35.7). Travel restrictions and quarantines in Europe and the U.S. are sure to cause the numbers to drop further.

“While we’ve already dipped below the lows experienced during Euro-area crisis and the oil bust in 2016—we’ll likely see PMI go lower before recovering, aligned with a return to more normal economic activity.”

By Seema Shah, Chief Strategist, Todd Jablonski, Chief Investment Officer and Binay Chandgothia, Portfolio Manager and Head of Asia

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