11 November 2020
By Mark van Moorsel, Co-Fund Manager DMS Verbatim Portfolio 5 Income Fund
In March, governments across the world scrambled to contain COVID-19 by imposing draconian restrictions on activity. As offices, shops, roads and rails emptied out, vast swathes of the economy were mothballed. Over the next six months, we witnessed both the sharpest contraction and the fastest rebound on record, driven entirely by governments’ decisions to restrict and then ease.
What happens next? The current pace of progress in therapeutics and vaccine development suggests that the road to a ‘virus free’ world is still some 9 – 12 months away. In the meantime, many businesses in the retail, leisure and hospitality sectors remain shuttered and the ranks of the permanently unemployed are on the rise. Moreover, the pandemic’s impact on the balance sheets of banks, households and businesses has yet to be felt. All these will likely hold back the pace of the recovery next year.
This challenging economic backdrop, however, seems to have had little bearing on the behaviour of financial markets: as Guy Monson writes in his Market View, global equity returns are positive for the year. Even emerging markets, which have poorer health systems and fewer policy buffers, have enjoyed positive equity market returns (chart 1). Only in the UK, where there is a potent mix of Brexit blues and excessive exposure to ‘old-economy’ sectors like financials and energy, have equity markets fallen.
Financial markets are rarely buoyant during recessions, particularly deep ones. Chart 2, which plots the S&P 500 Index during recessions and / or financial panics (1929, 1987, 1990, 2000, 2008 and 2020), illustrates this point. In this chart, the S&P 500 is indexed to 100 at the onset of a recession/correction and its subsequent course is then charted. A few points are noteworthy: in 2020, the S&P 500 (red line) initially fell as sharply as it had done in some of the deepest recessions (1929) and market dislocations (1987). Its subsequent bounce, however, has been remarkable, outpacing the recovery in both those episodes. Historically, equity markets have typically struggled after deep recessions and taken years to recover. The COVID-19 stock market has charted a very different course.
What is driving the disconnect?
The COVID-19 recession is like none other. Recessions are typically borne out of policy tightening intended to correct built-up imbalances within the economy. In contrast, COVID-19 is a ‘no-fault’ recession; it has been triggered by government action to restrict activity on account of public health concerns. In this context, policy makers have had little choice but to aggressively deploy fiscal and monetary policy to offset the government’s restrictions. Speed and agility replaced the hesitation and prevarication that typically accompany the start of a downturn. Countless emergency relief programmes were launched at a breakneck pace. While it is very easy to get lost in the details of these programmes, it vital to recognise the bigger policy shifts they represent.
This extraordinary crisis has jolted policymakers to break the mould. In particular, four specific policy shifts stand out.
In sum, an aggressive policy shift likely explains the market’s sanguine behaviour in the face of widespread economic trauma. Central banks and treasuries are committing to do ‘whatever it takes’ and stand ready to support the economy until there is a viable medium-term solution to COVID-19. This expansive commitment has allowed investors to treat COVID-19 like an extended natural disaster; investors are being encouraged to look through the present dislocation to the inevitable restoration of normality. As long as such support remains in place, asset prices can appear dislocated from the economy.
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