March has seen the market volatility of late February continue, but with even greater intensity. In the first two weeks of March, the ASX200 and S&P500 indices have fallen around 15%. This comes on top of their 7% - 8% falls in February. Developed country global equity markets are down 17% in March to date and emerging equity markets are down about 12%. Volatility is very high, with equity markets registering falls of 10% or more in a single day. These are some of the biggest single day declines since 1987's "Black Monday". Overall, this has so far been one of the fastest equity market corrections on record.
In other markets, government bond yields have fallen even further as investors price in further interest rate cuts. For example, in the US markets now expect the Federal Reserve to cut the cash rate from 1% to 0.1% at its meeting on 17-18 March. This follows the Fed's 0.5% rate cut just a few days ago. In Australia, markets expect the Reserve Bank to cut the cash rate to 0.25% in coming days. In response to this, 10 year government bond yields have fallen to 0.66% in Australia, and to 0.8% in the US. However, credit spreads have widened sharply as investor worry about corporate cash flows.
Currency markets have also been affected, with the A$ falling to around US0.63, its lowest level for a number of years.
The causes of this market volatility have attracted many headlines: the overvalued state of global equity markets, the spread of Covid-19, and the oil dispute between Saudi Arabia and Russia. Of these, the first set the scene, the second started the fire and the third just added more fuel. Coming on top of each other, these events proved a toxic mix for risk assets. Markets have been alarmed by the spread of the virus outside China and the increasing use of travel restrictions in response, which will add to downward pressure on global growth. The WHO's announcement of a global pandemic hit markets badly.
Not surprisingly markets are asking if this is the start of a new global recession, or perhaps even a new GFC. The likelihood of a recession is higher than that of a new GFC, though the damage that could be done to confidence should not be underestimated.
Support and stimulus from fiscal and monetary policies are expected. As noted above, further rate cuts are likely in coming weeks. In addition, the markets expect central banks around the world, including the Fed and the RBA, to start new Quantitative Easing programs as soon as possible. These more relaxed monetary policy settings are likely to be kept in place through the rest of this year and into next year as central banks seek to plentiful liquidity for the smooth functioning of financial markets.
While the markets want to see this support from central banks, they are also acutely aware that there is little room left to cut interest rates. Fiscal stimulus is urgently required to moderate the impact of Covid-19 on global growth. Here in Australia, the Federal Government has announced a stimulus package which has been generally well-received by economists and commentators, but more stimulus is expected in the May Budget. In the US, markets are worried that the rancour between the White House and the Democrats will hamstring any fiscal stimulus over there.
The bottom line is that while the risks of global recession have gone up significantly, there will be policy support, albeit with some caveats on the ability of traditional policy measures to offset a pandemic. At the moment, most analysts expect any recession to be shorter rather than longer, but that we will not see recovery before the second half of the year.
When will it end?
This is a very hard question to answer with any degree of certainty. The best we can say is, not soon enough. There are two key timelines here. The first is the course of the virus as it spreads between and within countries. The second, is the pattern of the economic data as the impact of the virus and travel restrictions show up in economic activity.
The first of these timelines leads the second. That is, until we can see the peak in the infection rate, we cannot estimate the timing of the trough in economic activity. In the meantime, we are likely to see some very weak economic growth figures from around the world. Within these, the key data to watch will be the labour market figures, especially in the US. Signs of an uptick in the US unemployment rate would confirm market fears about recession.
It is also important to note that the virus is only just starting to spread in the US. Its impact there will be even more important than its impact in China.
The markets will be encouraged by evidence of the peak in the virus, but their concerns about the effectiveness of fiscal and monetary policy support means they may not be as quick to price recovery as they might otherwise have been.
In short, we cannot say when the world will turn the corner on Covid-19 and its impact on the global economy. However, it is likely to be a matter of months rather than years and we know what to monitor to keep up to date on key developments.
We are going to see more volatility in markets in coming weeks as more data comes to light. Some of that data will encourage markets, while some will be received badly. Equity markets have fallen sharply enough to suggest markets are already pricing a recession, and perhaps even a severe one. On the other hand, traditional metrics such as price/earnings ratios have not yet fallen far enough to say that equity markets are outright cheap.
In this environment we will continue to run our strategy of diversifying our portfolio exposures while monitoring very closely key data and developments. This has served us well so far. While the portfolios have experienced negative returns in March so far, these have been much smaller than the falls in the equity markets and less than those experienced by some leading portfolio managers. This reflects the de-risking of the portfolios we began last November and extended recently. While the reduced equity allocations have under-performed, the increased allocations to hedges in fixed income, gold and selected infrastructure assets have helped the portfolios significantly.