Henrik Henriksen comment

27/03/2020

By Henrik Henriksen, Chief Strategist at Velliv

The vast majority of Western countries have in the past two weeks shut down large parts of their economies in order to prevent an uncontrolled spread of the coronavirus that would overwhelm their healthcare systems and result in drastic human consequences. The financial consequences are very serious. Yesterday, figures published revealed that 3.3 million Americans lost their jobs in a week! This is an unprecedented rapid increase - and it is also the fastest slowdown in the economy of the United States and the global economy on record. 

The largest aid packages ever from governments and central banks 
In this context, the governments of the United States and Europe have also this week passed the largest aid packages ever seen - and at a pace that is much, much faster than what was seen during the financial crisis. In the United States, Congress has passed an aid package totalling 2 trillion US dollars, the equivalent of around 9 percent of its GDP. In Germany, the Government has passed a 750-billion euro package, which is more than 20 percent of German GDP. The American and European initiatives are greater than those seen during the financial crisis and they have been passed in less than a month. In comparison, the initiatives during the financial crisis were passed over a 6-month period. 

What both the initiatives in the United States and Europe have in common is that they are distributing funds to both households and companies. Compared to previous crises, the United States has taken it a step further: The Federal Reserve now has the option - with the support of the Federal Government - to lend out 4.5 trillion US dollars to American companies via a number of different channels. Germany has also thrown their former caution to the wind and accepted a drastic increase in their deficit. We see the same thing happening across the European Union. The politicians are unanimous in their statements: If this is not enough, more will be provided. 

The global economy is in the midst of the most rapid downturn in history 
The financial impacts of the fight against the coronavirus have reached a point where the economies of the entire Western world are in the midst of the most rapid downturn in history - and the global economy has without a doubt entered into a recession in the month of March. Stock markets have fallen by 30 percent since their peaks. This equals the average decline during a recession, and represents about two thirds of the declines seen in connection with the financial crisis and the popping of the IT bubble around the year 2000 (in both of those crises, the stock markets fell by around 50 percent). Thus, the stock markets have already priced in a relatively short recession. However, the stock markets have not yet priced in a deeper and more drastic downturn where the economy needs a long time to get back on track due to unemployment numbers having risen so sharply, households and companies finding it a lot more difficult to find financing and companies having put a hold on their investments. 

The bad news is that we do not know how long it will take to fight the coronavirus and, by extension, how long and how severe this crisis will be. The good news is that banks and households are in a far better shape than they were in before the financial crisis, and the aid packages from the authorities around the world can draw on the experiences from the financial crisis. 

Massive aid packages will need a helping hand from the bond markets 
The initiatives that governments are implementing are the biggest in history in times of peace - and there is only one place to get the money: the bond markets. The type of aid packages that are passed these days are mainly aimed at supplying households and companies with liquidity so that they can pay their bills and continue their operations. Depending on how long and severe this crisis will end up being, there may be a need for a Round 2 where governments launch investments and projects, etc. to stimulate demand. If this happens, even more bonds will need to be issued. Therefore, it was of critical importance that the US Federal Reserve stated that they were willing to buy as many bonds as it would take. This is a signal to investors that there will always be a buyer of United States bonds - that buyer being the Federal Reserve. Without that statement, there was a risk that interest rates would rise significantly. 

We are in a guarded position - what would it take for us to be more positive? 

We have identified three sharp corners that we need to turn before we can begin to be more positive about stocks: 

1) Indications that the coronavirus infection rates have peaked in Italy. This week’s events would indicate that things are moving in the right direction. 

2) A similar development in the United States, not least in New York and California. The challenge here is that the United States is presumably a few weeks behind Italy in terms of the progression of the coronavirus, and the US healthcare system may be a wildcard in this context. The good news is that the United States has a younger population and many Americans are living much further apart from each other than is the case in Italy. 

3) A stock market stabilisation This week we have seen initial positive indicators. 

Global shares rose for several consecutive days this week, something they have not done since 12 February. This is an indication that the stock markets are becoming more balanced and that the dives that we saw in share prices in the last month may have levelled out. However, it is too soon to say that the stock market has turned a corner. We do not know how the coronavirus will spread and thus we do not know how long economies will remain in lockdown mode. On top of this, history teaches us that stock markets seldom see a V-shaped recovery after a huge dive in share prices. The process of the market finding a bottom may well take weeks or months to run its course. This is because the cause of a crash is seldom one that is gone from one day to the next. In 70 percent of cases where shares in the United States have fallen this rapidly, the first bottom of the market has not been the final one. The markets have had to go through a process of finding the bottom that ended up leading to a new and lower bottom before the bear market ended. 

The current uncertainty surrounding the coronavirus and the negative impact on cash flows for companies and households would suggest that the stock markets will once again have to go through such a period before things turn around. If there is a rapid normalisation of economic activity - together with the very rapid passing of aid packages - then the market may find its bottom relatively quickly. Conversely, a longer shutdown of the economy may increase the financial damage and mean that the stock markets will continue to see declines into the second half of the year as well.   

The long-term prospects for returns have improved 
It is also well worth noting that the long-term prospects for returns have improved significantly after share prices fell drastically in March. At the moment of writing, shares have fallen by 25-30 percent and this has noticeably improved the prospect for returns from shares in the next decade. The prospect of returns from corporate bonds has also improved, though the long-term expectations for returns from government bonds remain very low. 

We bring this up because pension savings are a long-term savings venture and there will inevitably be periods of great fluctuations, both up and down. If you follow your primal instincts and reduce risk when uncertainty is very high (and share prices are low) then there is a very significant risk that it may negatively impact your returns in the long run. In the long run, investments in real assets such as shares and real estate and alternative investments end up generating more returns than traditional bonds - not least now, where the unease has pushed interest rates to their lowest levels ever. This is why you need to think very carefully before you change your investing profile. 

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