Market Update - COVID-19 Consequences

Dancing in the Dark

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13/03/2020
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Equity markets have made some significant valuation adjustments in a very short space of time, pricing outcomes about which we know very little.

It seems likely that the COVID-19 virus has brought economies to a standstill, and yet none of this has yet become visible in the economic numbers. Perhaps the only exception is China’s manufacturing sentiment indicators which have collapsed to recession levels. Even there, however, the latest available data is unlikely to have fully captured the scale of the likely economic consequences of quarantine. With all this market volatility, we are essentially dancing in the dark.

One way to assess the likely balance of risks, however, is to compare the current stock market falls to others that have gone before. From the chart below, we can see that over the past forty-five years or so, the stock market has only had three more violent adjustments than the one we are experiencing now. The credit crunch was the most recent of these, and before that it was the dot com recession, and then the 1987 flash crash. While these events were all more serious than the current adjustment, we have no way of knowing if this current crisis could still get worse. Looking at it another way, equity market momentum has already deteriorated more than during the recessions of the late 1970s and early 1980s, the 1990 recession, the collapse of Long-Term Capital Management and the European debt crisis. That tells us that even if the economic impact of COVID-19 is global recession then equity markets have likely priced for that already. What we mean is that the medium-term balance of risks is now likely to be on the upside from here.

If our thinking on this is right, then the next question is at what pace are markets likely to recover? Given the nature of the problem and the available policy responses, our inclination would be to say slowly. That is because the bad news is likely to keep coming into the summer leaving the second half of the year as the recovery phase. So, while this might not yet be a buying opportunity, it may also no longer be correct to sell into this negative momentum either. Global multi asset diversified portfolios are well positioned to ride out the next phase of this crisis. There is nothing that is on fire, but we have certainly seen a few sparks. Hold tight, the worst of this adjustment is likely behind us already.

US equity momentum measured in standard deviations from average

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