March to date
March has seen the market volatility of late February continue, but with even greater intensity. In the first two weeks of March, the ASX200 and S&P500 indices fell around 22.3% and 18.3% respectively. This comes on top of their 7% – 8% falls in February. Developed country global equity markets to 17 March 2020 were down 20.4% with emerging equity markets down about 17.1%.

Volatility is very high, with equity markets registering falls of 10% or more in a single day. These are some of the biggest single-day declines since 1987’s “Black Monday”. Overall, this has so far been one of the fastest equity market corrections on record.

A day after recording the largest fall on record, the S&P/ASX recorded its largest one-day gain of 5.8% on Tuesday 17 March as investors snapped up blue-chip banks, healthcare, and mining stocks at reduced prices. In the retail sector, panic buying has flowed through to supermarket gains.

In other markets, government bond yields have fallen even further as investors price in interest rate cuts. On Sunday night the Federal Reserve cut their target cash rate to 0.0%-0.25% and announced that they would undertake $700 billion dollars of quantitative easing. This follows the Fed’s 0.5% rate cut just a few days ago. In Australia, markets expect the Reserve Bank to cut the cash rate to 0.25% in the coming days. In response to this, 10-year government bond yields have fallen to 1.01% in Australia, and to 0.70% in the US. However, credit spreads have widened sharply as investors worry about corporate cash flows.

Currency markets have also been affected, with the A$ falling well below US0.61, its lowest level since November 2008.

Global recession?
The causes of this market volatility have triggered many headlines: the overvalued state of global equity markets, oil dispute between Saudi Arabia and Russia, and the Covid-19 pandemic. Of these, the first set the scene, the second started the fire and the third added more fuel. Coming on top of each other, these events proved a toxic mix for risk assets. Markets have been alarmed by the spread of the virus outside China and the increasing use of travel restrictions in response, which will add to downward pressure on global growth. The WHO’s announcement of a global pandemic hit markets badly.

Not surprisingly markets are asking if this is the start of a new global recession, or perhaps even a new GFC. The likelihood of a recession is higher than that of a new GFC, though the damage that could be done to confidence should not be underestimated.

Support and stimulus from fiscal and monetary policies are expected. As noted above, further rate cuts are likely in the coming weeks. In addition, the markets expect central banks around the world, including the Fed and the RBA, to start new Quantitative Easing programs as soon as possible. These more relaxed monetary policy settings are likely to be kept in place through the rest of this year and into next year as central banks seek liquidity for the smooth functioning of financial markets.

While the markets want to see this support from central banks, they are also acutely aware that there is little room left to cut interest rates. Fiscal stimulus is urgently required to moderate the impact of Covid-19 on global growth. Here in Australia, the Federal Government has announced a stimulus package which has been generally well-received by economists and commentators, but more stimulus is expected in the May Budget. In the US, markets are worried that the hostility between the White House and the Democrats will hamstring any fiscal stimulus over there.

The bottom line is that while the risks of global recession have gone up significantly, there will be policy support, albeit with some caveats on the ability of traditional policy measures to offset a pandemic.

When will it end?
This is a very hard question to answer with any degree of certainty. The best we can say is, not soon enough. There are two key timelines here. The first is the course of the virus as it spreads between and within countries. The second, is the pattern of the economic data as the impact of the virus and travel restrictions show up in economic activity.

The first of these timelines leads the second. That is, until we can see the peak in the infection rate, we cannot estimate the timing of the trough in economic activity. In the meantime, we are likely to see some very weak economic growth figures from around the world. Within these, the key data to watch will be the labour market figures, especially in the US. Signs of an uptick in the US unemployment rate would confirm market fears about recession.

It is also important to note that the virus is only just starting to spread in the US. Its impact there will be even more important than its impact in China. That is because face-to-face service industries — the kind of businesses that go into a panic when fearful people withdraw from one another — tend to dominate economies in high-income countries more than they do in China. If people stay home from school, stop traveling and don’t go to sporting events, the gym or the dentist, the economic consequence would be worse.

The markets will be encouraged by evidence of the peak in the virus, but their concerns about the effectiveness of fiscal and monetary policy support means they may not be as quick to price recovery as they might otherwise have been.

In short, we cannot say when the world will turn the corner on Covid-19 and its impact on the global economy. However, it is likely to be a matter of months rather than years and we know what to monitor to keep up to date on key developments.

In summary

• Equity market volatility will continue however we will continue to see supportive monetary policy in the form of historically low short-term interest rates, as well as historically low long-term bond yields.
• In Australia, we are likely to see slower population growth (less immigration, flat wages and slower consumer spending growth).
• Domestically focussed businesses such as the major banks will need to get used to slower earnings growth.
• Internationally focussed businesses have the capacity to grow earnings more, assisted by a weak Australian dollar, however, given the current isolationist environment, this is not likely in the short-term.

Investment implications
We are going to see more volatility in markets in the coming weeks as more data comes to light. Some of that data will encourage markets, while some will be received badly. Equity markets have fallen sharply enough to suggest markets are already pricing a recession, and perhaps even a severe one.

During the uncertain times in the markets currently, it’s more important than ever for investors to understand the benefits—and limitations—of diversification. Having the right investment mix for your situation is critical in good times and during downturns. While you can’t control the ups and downs in the economy, diversification helps to limit the impact on portfolios.

There is no magic investment mix and what may work now can shift over time as economic conditions change. A diversified portfolio can look very different depending on the circumstances of the investor at the time. For example, factors such as income needs, investment time horizon, and the availability of other assets such as real estate or a pension will all play a role in shaping a well-rounded asset allocation.

What should investors do next?

• Speak to your adviser about any concerns.
• Ensure your investment portfolio remains relevant to their goals and objectives.
• When markets fluctuate, the human response is to act: ”buy more or sell”. While it can be difficult to overcome the gut reaction to act quickly to protect your money, remember to take a step back and understand the factors influencing the downturn before making any decisions.

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