As if the coronavirus crisis wasn’t enough of a challenge for the financial markets, the decision by Saudi Arabia to cut oil prices, and threaten to expand production adds another deflationary force in the global economy. Brent oil prices have fallen close to $14 to $31 and mark the most significant fall in oil prices since 1991.
The virus puts political regimes under pressure to breaking point. Last week’s OPEC+ meeting ended in disarray. The oil price fell 10% on the day with WTI at $41.28, a long way short of the approximate $55 average of the past year. Russia baulked at an OPEC call for 1.5m b/d of production cuts. The current OPEC+ agreement to restrain production ends at the end of March after which Saudi is threatening to expand production. Oil analysts now see an as much as 3.8m b/d in oil demand in the first quarter the largest drop on record.
Lower oil prices will transfer spending power to oil consumers such as Japan and India from the Middle East. However, they will also further deflate the global economy as headline inflation falls away, and oil production economies see a sharp drop in GDP.
We expect the coronavirus issue to continue to weigh on markets with likely further downside in equities and credit markets. Much will depend on how Europe and the United States handle the crisis – the omens don’t look good.
The virus is out of control in Italy as the whole country is now under quarantine and the Italian government is negotiating with the banks for mortgage relief in the Coronavirus crisis.
Now nearly every EU country is impacted. Medical opinion is very much of the view that we are only at the start of the spread of the virus. In the United States, the late decision to screen people as they arrived at airports from abroad and the incredible lack of testing kits likely means that the virus is more widespread than currently known. In the week that Singapore announced it was manufacturing its own virus testing kits, it is beyond belief that the U.S. can muster no more than 2,000 tests in a week and is thought to only have 6,000 kits in total.
As markets have started to begin to panic, Economists are finally starting to put more realistic numbers on the damage to the global economy. But a few weeks ago, the IMF suggested that global growth could be hit by 0.1%. Oxford economics recently indicated that the health crisis would knock $1 trillion off $86.6 of global GDP. The OECD last week lowered its global GDP forecasts by half a percentage point to just 2.4% the lowest rate since the world financial crisis. Bloomberg economists put the hit to global GDP at $2.7 trillion in a worst-case scenario. To be frank, the economists are chasing their tails trying to get ahead of the news flow.
Markets are at a critical juncture, and investors need to proceed, from here, with great caution. It is not a fruitful exercise to guess how extensive the spread of the virus will be before it abates.
As the count of virus-infected people rises in the coming weeks, the risk markets look vulnerable to the downside. It’s anyone’s guess how far investor fear will push asset class prices. Equally, attempts at quantifying its effect on markets are just wild shots in the dark. Some parts of the fixed income market are getting close to pricing in a recession – not credit, but government bonds – while volatility has spiked to very alarming levels.
We are worried that equity markets may fall to the lows of December 2018, a 20% fall from current levels of the S&P 500.
Equity and credit markets were priced for goldilocks by the end of January this year. For the last decade, the Central Bank Put has been in place. Through either rate cuts or quantitative easing or both, it has been possible to backstop economies and investment markets. We seriously questioned whether such policies will have the desired effect now. No wonder then that the money market is pricing in two to three more rate cuts from the Fed to January 2021. The Fed jumped on the panic button by cutting by 50 basis points last week.
We have 12-18 months to navigate where the root problem of the virus originated. Containment can only come with severe restrictions on people and hence on growth. This is different. Central bankers cannot control it. Money provides relief but not a solution, unlike the world financial crisis. With so many disruptions and anomalies going on, it is worth reminding us of a key lesson learnt in the GFC.
It is that after the initial shock (dare we say “contagion”) the underlying quality of the asset had little to do with its immediate future performance. A large proportion of the losses registered in certain assets had very little direct correlation with either sub-prime debt or the collapse of Lehman Brothers. However, the crisis shattered market confidence and liquidity disappeared.
Behavioural finance explains a little of what has gone before us in the year so far and what may come to pass.
Overconfidence was clearly in play when economists and dare we say it the U.S. President believed they knew better than the medical expert advice. Many spouted that coronavirus outbreak would be over in a couple of months. How many times did we read about V-shaped recoveries? The continued belief that the outbreak will constitute, in hindsight, just another dip to buy, is truly dangerous.
Given the emotion of investors at the moment, it is worth keeping in mind the six core human emotions and how they may play out in the coming months. December 2020 was happiness as investors bet that central banks would continue to underpin the markets with easy money. By February 2020, there was a surprise as the coronavirus took hold, recognising that is was well beyond the simple flu. Through the first week of March, there is clear fear. Beyond fear, there is anger, disgust, and sadness. Policymakers who clearly fail their countries beware.
Careful! There is no reason to have such blind faith. Shortages due to coronavirus will be far worse than expected – but most companies are unaware of their exposure. The reality is, most big companies are just waking up to this. A better course of action will be one that takes on board a heavy dose of caution and position investment portfolios accordingly.
