After a tumultuous couple of months in March and April, a semblance of calm had returned to global financial markets in May. The first half of June, however, has seen volatility return: stock markets have once again been registering significant gains or losses on a daily basis (see Figure 1).
Figure 1: Daily moves in the FTSE All Share index of UK stocks, year to date
Stock market turbulence is a reflection of the tug-of-war between the coronavirus and policymakers around the world. The relative tranquility of May was driven by evidence that social distancing policies were succeeding in containing the virus and that stimulus measures from governments and central banks were working to limit the worst of the economic fallout from lockdown. With policymakers seemingly gaining the upper hand, investors looked towards a brighter future, with the threat of the virus receding and the global economy re-opening. More recently, investors have had cause to question this outlook.
Though questions remain about the Chinese authorities’ initial response to the coronavirus outbreak, the strict lockdown measures subsequently imposed had appeared largely successful. Daily new infections dropped to single digits nationwide, and economic activity returned to around 90% of its pre-Covid levels. However, after a string of new outbreaks, China has been forced to reimplement lockdown in Beijing, shutting schools, cancelling flights and increasing testing.
Meanwhile, just days after lifting lockdown and declaring the virus eradicated within its borders, New Zealand is once again reporting new cases of infection. Though the numbers involved in both instances are small in comparison to the huge toll on lives worldwide, the resurgence of Covid-19 in China and New Zealand has served to demonstrate that, without an effective and widely available vaccine, the pandemic threat remains real.
Evidence of the coronavirus’ ongoing threat naturally casts a shadow over efforts to ease social distancing measures and resurrect economic activity. These shadows are arguably longest in America. Infection rates are worryingly high and, furthermore, are rising once more in a number of US states, including California and Texas. Nonetheless, there is significant resistance to lockdown measures among the populace and politicians. Eager to re-start the economy, the Trump administration has ruled out the reimposition of lockdown measures in the event of a second wave of infections.
Though trials in the UK suggest Dexamethasone – an inexpensive and widely available steriod – significantly reduces fatality rates among those with severe coronavirus symptoms, recent coronavirus developments have largely been negative. As has become habit over the past decade or more, investors have turned to policymakers for a response.
The response this week has been signficant. The Federal Reserve – the US central bank – started buying $25bn of corporate bonds each week, helping ensure companies hard-hit by the economic impact of lockdown have access to a steady stream of financing. Meanwhile, President Trump has mooted a trillion dollar fiscal stimulus plan1 focused on improving America’s creaking infrastructure. In Japan, the central bank has declared its quantitative easing2 programme ‘effectively limitless’ and ramped up its special Covid-19 lending stimulus from ¥75tr to ¥110tr. In the UK, the Bank of England increased its bond buying by £100bn, taking the total to £745bn.
These measures arrive in the wake of policy support that has already dwarfed that unleashed throughout the entirety of the period since the collapse of Lehman Brothers in September 2008 signalled the onset of the Great Financial Crisis. Though economic data covering March and April are unsurprisingly weak, more recent releases have suggested that the decisive response of policymakers has had a significant and positive impact on the global economy. For example, after a horrifying number of job losses in March and April, two-and-a-half million new jobs were created in the US in May. Meanwhile retail spending in America jumped nearly 18% last month, leaving sales down ‘only’ 6% year-on-year – a far better result than had been expected.
While the global policy response – particularly that from the US Federal Reserve – has undoubtedly limited the economic fall-out of the pandemic thus far, the question is whether it can continue to do so. We have argued that the likelihood of success is directly linked to the length of time over which extraordinary policy support is required.
A resurgence of the pandemic threat is therefore of significant consequence. If a second wave of infection puts a further break on economic activity – whether mandated by governments or prompted by individuals’ concern for their wellbeing – it will become increasingly hard for monetary and fiscal policy to keep the global economy in sound working order, ready and waiting to spark back into life at the first opportunity.
Globally, government debt has now reached levels not seen since World War II and interest rates across major economies are close to – or even below – zero. Nonetheless, we believe policymakers still have the scope to support the global economy for some time yet to come. A first step may be for governments to follow France’s lead and extend extraordinary wage support policies beyond their current deadlines (these measures are due to end in July in the US and October in the UK).
With some creative thinking, we believe the burden of debt created by such intiatives can be managed. At the same time, debt levels are now so high that, crudely, the tug-of-war against the coronavirus is a game policymakers cannot afford to lose. In short, we expect policymakers to unleash further monetary3 and fiscal stimuli in due course.
The timing, scale and nature of the policy response will do much to shape the outcome for investors over the next several years. The political will required to sanction stimulus measures is significant: it is possible that further bad news will be required to prompt policymakers into action. Investors should therefore brace themselves for ongoing market turbulence in the near term as the battle between the coronavirus and policymakers is waged. Should policymakers triumph as we expect, we believe long-term investors will be rewarded for their resilience during this period.
On the basis of the post-financial crisis experience, investors should expect stimulus measures to support prices of both equities and bonds. Loose monetary policy may suppress day-to-day volatility – but arguably only at a cost of greater fragility, with financial markets susceptable to infrequent but significant dislocations. This fragility argues for the retention of high quality bonds, which are still the best hedge against stock market risk.
However, this appeal is tempered by the potential for stimulus to trigger inflation which would detract from the already low income available to bond holders. Inflation would also require a discerning and active approach to stock selection as it would eat into the profit margins of companies that are unable to raise prices to offset increases in their costs.
As recent developments have made clear, the pandemic threat of the coronavirus remains real. The economic cost of efforts to limit the human toll exacted by the virus is pronounced. Ordinarily, this would be sufficient to signficantly darken the outlook for holders of stocks and shares. However, the response from policymakers has been anything but ordinary – and we believe more is yet to come. Though acknowledging that their task becomes harder the longer the pandemic threat persists, we believe ongoing monetary and fiscal stimuli will, in due course, outweigh the adverse economic impact of the coronavirus. This stands to benefit those who understand their willingness and ability to tolerate short-term losses in pursuit of their long-term goals, and who have sought out a considered, diversified and discerning approach to investment.
Deputy Chief Investment Officer, Omnis Investments Limited
Issued by Omnis Investments Limited. This update reflects Omnis’ view at the time of writing and is subject to change. The document is for informational purposes only and is not investment advice. We recommend you discuss any investment decisions with your financial adviser. Omnis is unable to provide investment advice. Every effort is made to ensure the accuracy of the information but no assurance or warranties are given.
The Omnis Managed Investments ICVC and the Omnis Portfolio Investments ICVC are authorised Investment Companies with Variable Capital. The authorised corporate director of the Omnis Managed Investments ICVC and the Omnis Portfolio Investments ICVC is Omnis Investments Limited (Registered Address: Washington House, Lydiard Fields, Swindon, SN5 8UB) which is authorised and regulated by the Financial Conduct Authority.
1Fiscal policy typically relates to government spending. Governments can boost current economic activity by borrowing to fund an increase in current expenditures on projects that will employ resources that might otherwise be idle and that might themselves be expected to support future economic activity (e.g. building new roads or supporting increased access to the internet).
2Quantitative easing (or “QE”) is where a central bank creates new money and uses it to buy securities – typically government bonds, but increasingly also corporate bonds – from asset owners, thereby forcing the new money into the financial system.
3Monetary policy is typically overseen by central banks such as the Bank of England and the US Federal Reserve. Historically the prime policy tool has involved setting interest rates, but QE has played an increasing role since the financial crisis.