COVID-19 and Stockmarket Update
We are living in unprecedented times. Newsflow currently remains grim and despite the huge intervention by governments and central banks, stockmarkets remain spooked. What we do know is that keeping people inside their homes will have a negative impact on economic growth. People will buy less, sell less, and make less. However, this is likely to be a temporary shock – we currently have no idea how long this will drag on for but it is certainly not a permanent state of affairs.
Some commentators fear another financial crisis. Financial crises are different to normal recessions: they tend to be deeper and with less of a V-shaped recovery. We do not think that a financial crisis is very likely.
There is a significant amount of published literature on financial crises, and they almost invariably have common markers:
- They tend to be preceded by an extraordinarily rapid increase in borrowing (of a speed that we have not seen over the last 10 years), this is often as a result of financial de-regulation (quite the opposite today) and an overextension of credit to un-creditworthy borrowers as a result of imprudent lending standards, especially by weak banks with inadequate capital (again no systemic evidence of that today).
- Most are also associated with banks becoming dangerously exposed to a highly leveraged asset classes such as property, which is used in turn to collateralise yet more loans. Again, there is little evidence of this today.
In short, we see little evidence that a temporary Covid-19 induced recession will trigger a financial crisis. Especially when we consider that monetary policy is currently set so loosely – most recessions, and especially financial crises, are triggered by a monetary policy mistake.
Obviously, we don’t know what will happen next and the fear levels are increasing as governments take visible action, closing down areas, making public advice announcements and limiting travel. This has led to panic in the markets and equity markets have lurched lower on the news. To make matters worse Saudi Arabia and Russia have engaged in a price war sending the oil prices down by more than a quarter.
All Bear Markets (a stockmarket fall of over 20%) have a different cause – this one brought on by the Covid-19 virus whilst the previous one in 2008 was caused by overleveraged US homeowners – but they also lay the foundations for the next Bull Market. Given the speed of the decline it may well be that the recovery, when it starts, is equally dramatic.
For longer term investors current valuations appear attractive across most major stockmarkets (note the US, even after recent falls appears expensive).
Based on history the current valuation for UK smaller companies, as an example, are beginning to be very attractive.
As per our note last week we have taken action across client portfolios and built up cash reserves. Whilst the market moves of the last month have been brutal, there are good reasons to remain invested. Ultimately, we believe that it will be proven that the economic cycle has been extended, not destroyed, by these recent events. We anticipate continued strong policymaker responses to be announced to help buttress economic and investor confidence and sense that investors are beginning to capitulate, which is a prerequisite for identifying peak pessimism, and therefore, a potential buying opportunity.
Should you have any questions about your investments with Quartet then please do not hesitate to contact us, and we will continue to update you on market developments.
Quartet Investment Managers – 20th March 2020