Fear has the upper hand now the Covid-19 coronavirus is officially a pandemic. The World Health Organisation (WHO) reports total cases worldwide at 132,567 and there have been 4,947 deaths as of 13 March. The S&P 500 index of leading US shares fell almost 10 per cent on Thursday after London’s FTSE 100 closed a third below the all-time high it reached in January. The UK market has opened positively on the ominous Friday the thirteenth, but investors will remain cautious the response to further stimulus measures could wain once more.
Investors continue flight to safety
Bears are growling loudly at share prices and investors have rushed towards haven assets such as government bonds. The 10-year US treasury yield has bounced off all time lows but is still below 1 per cent – a negative real rate of return – and UK 10-year gilts offer even less, just 0.28 per cent. Even the gold price fell on Thursday, down to $1,583/oz, with traders blaming the need for portfolio managers to liquidate holdings to fund losses on other asset classes. The pull-back is perhaps an entry point for investors who see the yellow metal as a good bet in the coming months.
Rishi Sunak (centre) is shown the testing of samples for respiratory viruses
Baptism of Fire is an overused cliché but apt to describe UK chancellor Rishi Sunak’s maiden budget on Wednesday. The 39-year-old shredded borrowing rules to promise £30bn of fiscal measures (tax cuts and government spending), hot on the heels of the Bank of England’s unscheduled monetary policy announcement – cutting interest rates to 0.25 per cent.
Despite expanding the European Central Bank’s quantitative easing programme, promising to buy another €120bn of bonds a month, and improving the lending scheme for banks, ECB president Christine Lagarde fluffed her lines on Thursday. Trying to walk the political tightrope, Ms Lagarde asserted that narrowing the spreads between Italian and German government bonds was not her priority. Her speech prompted unwelcome selling of Italian debt.
President Donald Trump defended his decision to announce a suspension on arrivals from the EU without informing European governments, telling reporters Thursday there wasn't enough time | AFP
The US Federal Reserve led the way on monetary policy, as well as the rate cuts ahead of its regular policy meeting, its New York branch has significantly increased liquidity support for the overnight lending (repo) market. Unfortunately, partisan politics have held up the US fiscal response – the impasse in Congress stemming from the Democrats' reticence towards giving President Donald Trump too much of a fillip in an election year.
In any case, with economic activity on shutdown, there is little possibility for companies to generate cash from operations. Consequentially, investor demand for credit is dissipating rapidly, which along with the flight to government bonds is seeing the spread between corporate bond yields and interest rates widen. This makes it harder and more expensive for companies to re-finance as debts fall due which, along with the weakened trading outlook, raises the likelihood of defaults.
The task for governments around the world is to gain the upper hand on the pandemic and keep the lights on for the economy. The violent collapse in share prices reflects the stretched valuations markets were on and the likelihood of drastic downgrades in profit forecasts. Theoretically, it is possible investors fleeing from passive index funds has caused heightened velocity of selling, although thus far fears such products would fail to track their benchmarks in a major stress event haven’t been realised.
On the plus side, although the risk to life for specific vulnerable people is serious, the experience of countries worst affected by Covid-19 strongly indicates this is no Black Death or Spanish Flu. Therefore, the challenge is weighing up the hit to company profits this year, against the positive impact to be felt once the virus has subsided and stimulus measures boost the economy.
