Feb. 29, 2020
Covid-19 sparks one of the fastest slides since the second world war
THE SPEED of the sell-off in global stock markets is remarkable. On February 19th the S&P 500, America’s main index, reached a record high. Little more than a week later, it has lost one-eighth of its value. The change in mood is astonishing. Last year was the best for global equities since 2009, with the MSCI world index rising 24%. A week of turmoil finished only when traders headed home for the weekend on February 28th. Japan’s Topix index had fallen by 9.7%, the Euro Stoxx 50 by 12.4% and the S&P 500 by 11.5%, its biggest weekly loss since 2008.
Investors had begun 2020 in an optimistic frame of mind. Bank of America’s monthly survey of global investors, taken during the second week of February, found that investors expected world economic growth to strengthen this year and profits to improve. They had positioned their portfolios accordingly. Their weighting in equities was at a 20-month high and their cash holdings at a 58-month low. Just over a fifth of fund managers saw the coronavirus as a significant risk, but even more were worried about the American presidential election or a sudden collapse in the bond market.
In early February, investors’ main assumption was that the virus’s impact on the global economy would be felt through disruption to the global supply chain, caused by the extended shutdown of Chinese factories (after the lunar new year holiday), and through reduced Chinese demand for commodities. Bloomberg’s commodity index fell by 9.3% between January 6th and February 3rd.
But in the past couple of weeks, the virus has spread to South Korea, northern Italy and other countries. Corporate gatherings, including this month’s Mobile World Congress and next month’s Geneva motor show, have been cancelled, and firms such as Nestlé and L’Oréal have suspended international business travel. Companies such as Adidas, Apple, Mastercard, and Microsoft have all given warnings that the virus will dent their revenues or profits.
All this has caused economists and analysts to revise their forecasts for this year. Bank of America forecasts global GDP growth of 2.8%, the slowest since 2009. Citigroup now thinks global corporate earnings will not grow at all this year; before the virus worsened, the consensus was that they would rise by 9%. The upending of these forecasts alone can explain much of the stockmarket’s decline.
A stock market “correction” (ie, a fall of 10%-plus from a peak) should hardly be a surprise: the bull market for stocks is aged, having begun in the spring of 2009. Many crises have been surmounted along the way, as investors have often been driven back into equities by the poor returns available on other assets, notably cash and government bonds. This pattern could yet be repeated; analysts at Morgan Stanley regard the virus outbreak as a “transitory exogenous shock” which will be followed by a recovery.
But recent history suggests caution. Shares rallied impressively in 2017, after the election of Donald Trump to the American presidency and an easing of fears about the Chinese economy. As the Federal Reserve started to push up interest rates, investors hoped that economic conditions could return to “normal”, or at least the normality that prevailed before the financial crisis of 2007-09.
A disconnect in the market appeared in 2019. Equity prices continued rising in the hope that the global economy (and corporate profits) would grow strongly. But government bond yields fell (see chart), normally a sign that investors are worried about the economic outlook. On February 27th the yield on the ten-year Treasury bond sagged to a record low of 1.16%, indicating that investors are extremely risk-averse. If the bond market is right, a recovery in the stockmarket may be a while in coming.
