Feeling Sick: Markets Take a Black Swan Dive

James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager

• The coronavirus (COVID-19) is a black swan that has radically changed the global economic outlook. The US has gone from a full-employment economy to something that can be compared to the devastation wrought by the Great Depression within a matter of weeks. The emergence of the COVID-19 has caused financial markets to plunge almost everywhere as the global pandemic spreads rapidly across much of the world.
• The incredible volatility exhibited by stocks and bonds globally indicates that investors have had a tough time pricing the uncertainty that has enveloped the world economy. Sharp equity-market corrections have been recorded in many countries and regions. The onslaught of developments presented by the spread of COVID-19 and a simultaneous collapse in oil prices has forced financial markets to recalibrate prices sharply as expectations about different industries and the overall economy shift at a breakneck pace.
• Sovereign-bond prices in most countries have soared as investors turn to the perceived security of debt issued by national governments, and credit spreads have widened dramatically. Trading in global bond markets has been chaotic, bringing back bad memories of the global financial crisis.
• China now seems to be recovering, but the ramp-up is slow. A steep decline in demand for the country’s goods in the months immediately ahead, especially from Europe and the US, may hold back its rebound. China’s internal consumption, however, should rise smartly.
• The ultimate impact on US gross domestic product is truly anybody’s guess. The first quarter could see a decline at an annual rate of 3% to 5%. The second quarter will likely be one for the record books. The sudden and widespread stop in US economic activity is something that has never been experienced on such a scale before. And it came at a time when the US economy, indeed the global economy, appeared to be on an upswing.
• The US Federal Reserve (Fed) and other leading central banks have moved with an alacrity and forcefulness that we find commendable. But central banks cannot single-handedly support this economic shutdown. Fiscal policy—in the form of direct income support, tax deferrals, loan guarantees and outright bailouts of badly damaged industries—must be the prime tool used to conduct this war.
• The US Congress has passed into law a fiscal response that should top 10% of GDP—meaning that the overall deficit this year in the US could approach 15% of GDP. Other developed countries are looking to pursue a similar strategy of massive income support and liquidity injections. Germany, a country that typically keeps its wallet closed, is setting the example for Europe with a package that includes loan guarantees for both large and small businesses.
• Few other countries in Europe have the fiscal strength of Germany. Italy, the European epicentre of COVID-19, will be particularly hard-pressed to do all that will be needed to stabilise its economy. Italy’s government debt to GDP is already heads-and-shoulders above other major European countries.
• Nobody knows how much weaker global stock markets will get. It depends on the trajectory of the COVID-19 in Europe and the US, the robustness of government responses, and the extent to which the economic shock feeds on itself in terms of corporate financial distress and layoffs.

A full-length paper is attached if you wish to learn more about these timely topics.

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