A week of extreme market fluctuations

A particularly volatile week

The Eurostoxx50 index fell by 20% last week, ending the week 34% below its 19 February high. In the US, the S&P500 index plunged on Friday to 27% below its recent record but managed to rise by almost 10% on Friday.

Volatility also dominated commodity markets, bond markets and currency markets. The oil price slumped 30% on Monday 9 March in the absence of an agreement between OPEC and Russia. It is striking that the sell-off affected almost all assets, even safe havens, such as gold (-9%) and bonds. After the new lows hit by bond yields on Monday 9 March (0.5% for the 10-year Treasury rate and -0.8% for the German bund), profit-taking took place in the following days and rates started to rise again.

Investors are beginning to worry about the growing fiscal deficit in southern European countries following the measures taken to stem the coronavirus crisis. In addition, the markets had probably hoped for a more forceful intervention by the ECB. The central bank decided to inject additional liquidity and temporarily double its bond-buying programme, but some had also expected a rate cut, which is, of course, difficult when the policy rate is already 0% and the deposit rate is -0.5%. Other central banks, which still had enough room for manoeuvre, cut rates substantially.

Luck can turn

Last month, the stock markets were still quietly setting new records and nothing seemed likely to destabilise investors. In a few weeks, however, sentiment has gone to the other extreme. While the markets were still assuming last month that the economic fallout from the coronavirus epidemic would be limited to China and a temporary interruption of supply chains for some companies, the rapid spread of the pandemic is now crippling entire areas of economic life around the world. 

In recent months, we have repeatedly highlighted the gap between equity and bond markets. The succession of stock market records seemed to suggest that equity markets were expecting a good economic climate, while record low rates and the inverted yield-curve foreshadowed a recession. Only one of the two arguments could be correct, and it is now clear that the bond markets were right. Indeed, a recession has now become inevitable in the first half of 2020, even if it is, after all, due to a 'black swan'.

An abrupt (albeit short-lived) recession

After China, containment is now affecting large parts of Europe and the rest of the world. Many public and economic activities must be suspended: air traffic, hotels & restaurants, shops, cinemas, sporting and cultural events, not to mention many commercial and industrial activities. This will lead to loss of revenues, temporary unemployment, fear of bankruptcies and credit losses In short, all this will greatly hurt consumer and business confidence. Manufacturing had already sunk into a recession last year, but consumption and the services sectors propped up the economy. Now these sectors of the economy are the hardest hit.  Nevertheless, we continue to hope that this recession will be short-lived.

As for the duration of the pandemic, we can draw hope from the example of China. The number of new cases of infection there is falling by the day, and more than 80% of patients are cured. After about six weeks, a large slice of the population is developing enough anti-bodies, and quarantine measures have been relaxed. On this basis, we are of the opinion that the draconian quarantine measures should last between 3 and 6 weeks in Europe. The worst economic fallout is therefore expected in March and April. From May, we expect economic life to gradually get back to normal.  However, some sectors (e.g. the aviation sector and tourism) have been badly affected, and they will feel the effects of the crisis for some time to come.

Authorities and central banks to the rescue

For this reason, many authorities are introducing incentives, such as postponing tax payments, temporary unemployment and tax incentives that will enable consumption to resume rapidly once containment is lifted. Germany and the United States particularly have already announced colossal incentives.

Central banks, too, are being quick to respond. After cutting rates by 0.50% two weeks ago, the US Federal Reserve once again cut its Fed funds rate by a full percent point in one shot, taking it to the absolute floor of 0-0.25%. In addition, the Fed is also launching a new bond-buying and corporate credit programme worth $700 billion. All these measures are designed to provide the financial system with enough liquidity, and to ensure that companies, households and governments will continue to have access to cheap credit. Other central banks have followed suit, with rate cuts in the UK, Canada and Australia, and increased quantitative easing in Europe and Japan.

The sharp correction in stock markets offers buying opportunities

Therefore, 2020 will be a cyclical bottom, both for the economy and for company earnings. After stagnating in 2019, corporate profits will not experience the recovery hoped for in 2020 (when they may even decline), but only in 2021. However, stock markets always anticipate 6 to 9 months ahead, and the best buying opportunities arise at the start of a recession. With the corona-uncertainty at its worst, we cannot rule out volatility persisting in the next two weeks. However, it is likely that share prices will reach their bottom in March before resuming a recovery as from April when the pandemic has passed its peak.