Global pandemic – entering period of unprecedented economic events and market volatility | Luminor
>

Atis Krūmiņš
Head of Investment Management
 

By any criteria, March was historic month that will be remembered for a long time to come. Number of coronavirus cases around the world was constantly increasing, and in more and more countries COVID-19 epidemic was getting out of control. For the most of March most disturbing virus trends were registered in Europe, especially Spain and Italy, but by the end of the month around one fourth of all global cases became attributable to USA. As a result, governments had to implement radical quarantine measures to contain the spread of the virus, such as closing borders, prohibiting international travel, limiting movements inside their countries and putting various restrictions on how businesses should operate.

Daily global & USA coronavirus cases

Source: Bloomberg

These are efficient measures to save lives and protect health of citizens but, unfortunately, such measures come at a cost as they also lead to extremely severe economic damage. As large share of companies stop making services or producing goods, while consumers sit home and do not make any purchases1, revenues of such enterprises abruptly become almost non-existent. In its turn, companies have to start cutting costs almost immediately, by reducing number of their employees, abandoning investment plans for future growth and undertaking other measures to save money, be able to repay debts and not go out of business. This is not exaggeration, already in March most severely hit industries, such as airlines, hotels, cruise lines and others were asking for government bailout, as risks of them going bankrupt were rapidly increasing. As a result, industries that were considered relatively stable just in February went down in price by as much as 60% in less than one month.  

Performance of S&P-500 and selected industries in 2020

Source: Bloomberg

Macroeconomic consequences also become very discouraging. From available numbers, we have already seen record low economic activity in services industry in USA and Eurozone in March, and extraordinary high rise in initial weekly unemployment claims in USA. During only two last weeks in March, around 10 million US citizens have lost their jobs, and in the upcoming weeks this number may become even higher. And though it is still too early to make reliable forecasts for the upcoming months, according to Goldman Sachs in second quarter 2020, US economy may shrink at around 8% compared to first quarter 2020, and unemployment may soar up to 15% by mid-year. 

Services PMIs

Source: Bloomberg

US initial weekly unemployment claims

Source: Bloomberg

For financial markets developments in end of February and March were also totally unexpected. In mid-February, equity markets were updating new all-time highs, and there was consensus among market participants that COVID-19 spread would be mostly limited to China and some isolated cases elsewhere. However, when evidence from other countries started to indicate that risk of global pandemic is rising, panic at financial markets went to unprecedented levels.

Never in history equity markets declined from the top by 20%2 in such short period of time, and only during Wall Street 1929 crash and October 1987 immediate drop from the top was so significant. In addition, never in history, consequent 20% rally after such crash happened in such short period of time (3 days). If we take statistics on largest daily changes for S&P-500, during March index registered third (-11.98%) and sixth (-9.51%) largest daily declines ever, and also registered ninth (+9.38%) and tenth (+9.29%) largest increases ever. Not a single month in history was able to generate such abnormally high up and down volatility.

Worst declines from S&P-500 all time high in history

Source: Bloomberg

Best and worst S&P-500 performance by days

Source: Bloomberg

To provide economic support and help stabilize financial markets, central banks and governments had to announce record amount of monetary and fiscal stimulus. The list of taken actions is truly large and we will only mention most significant ones:

Even during 2008-2009 financial crisis amount of stimulus was not as large as during one month of March, so these measures are indeed exceptional. Hopefully, they would allow to smooth negative economic impact from COVID-19 and speed up recovery after pandemic is behind us. This is why, financial markets were able to somewhat stabilize by the end of March and recover part of their losses.

If world will indeed be reopened in the nearest future, with new money entering economic and financial system through stimuli, economic growth would return and inflation would pick up.  Asset prices in that case may experience strong rally. Since 2009 every time FED increased its balance sheet and launched QE programs, equity prices rallied subsequently. Will it be different this time?

Increase in FED balance sheet vs performance of S&P-500

Source: Bloomberg

Unfortunately it might be different this time. As we constantly described in our overviews throughout 2019, even without coronavirus impact, global economy was already in late cycle and running close to maximum capacity, while too much debt was used unproductively. For example, already mentioned airlines were actively buying back their shares from the market by issuing new debt, but now do not have adequate cash reserves to survive without government aid. So even after coronavirus crisis is resolved, there is no guarantee that countries would be capable to return to previous levels of growth fast enough.

In addition, it is absolutely unknown, how long would it take for coronavirus situation to resolve. Even if life is back to normal in affected countries after several months, who could guarantee that there would not be second wave of virus spread say in autumn, similar to how it happened during Spanish Flu epidemic in 1918. As a result, with future being so unpredictable, companies and individuals may become reluctant to spend money, take new debt and increase consumption even after crisis is over. Companies would continue to reduce costs by cutting labor force and not undertaking new investments. In such scenario deflationary pressures would be significant, recession would last longer than planned and financial assets would continue going down in price.

Long term inflation expectations

Source: Bloomberg

This is exactly why governments and central banks have acted so fast by introducing such enormous stimulus packages. We hope their actions would be enough to prevent more prolonged depression.  In times of such unprecedented uncertainty and extreme volatility it is especially important to stay rational and stick to your investment plan. If your goals and financial circumstances have not changed, the movements in the market are not a good reason to change the plan. Additionally, it usually doesn’t pay off trying to catch a bottom, as it is extremely hard. However, using regular contributions to long term investments may be a good way to take advantage of lower prices in the market.


1Apart from basic necessities

2Widely used threshold to indicate start of bear market

DISCLAIMER

Warnings

  • This Marketing Communication is not considered investment research and has not been prepared in accordance with standards applicable to independent investment research.
  • This Marketing Communication does not limit or prohibit the bank or any of its employees from dealing prior to its dissemination.

Origin of the Marketing Communication

This Marketing Communication originates from the Portfolio Management unit (hereinafter referred to as PMU) – a division of Luminor Bank AS (reg. No 11315936, with registered address at Liivalaia 45, 10145, Tallinn, Republic of Estonia, represented within the Republic of Latvia by Luminor Bank AS Latvian branch, reg. No 40203154352, address: Skanstes iela 12, LV-1013, Riga, hereinafter - Luminor). PMU is involved in the provision of discretionary portfolio management services to Luminor clients.

Supervisory authority

As a credit institution Luminor is subject to supervision by the Latvian Financial Supervisory Authority (Finanšu un kapitāla tirgus komisija). Additionally, Luminor is subject to supervision by the European Central Bank (ECB), which undertakes such supervision within the Single Supervisory Mechanism (SSM), which consists of the ECB and the national responsible authorities (Council Regulation (EU) No 1024/2013 - SSM Regulation). Unless set out herein explicitly otherwise, references to legal norms refer to norms enacted by the Republic of Latvia.

Content and source of the publication

This Marketing Communication has been prepared by PMU for information purposes. Luminor will not consider recipients of this Communication as its clients and accepts no liability for use by them of the contents, which may not be suitable for their personal use.

Opinions of PMU may deviate from recommendations or opinions presented by the Luminor Markets unit. The reason may typically be the result of differing investment horizons, using specific methodologies, taking into consideration personal circumstances, applying a specific risk assessment, portfolio considerations or other factors. Opinions, price targets and calculations are based on one or more methods of valuation, for instance cash flow analysis, use of multiples, behavioural technical analyses of underlying market movements in combination with considerations of the market situation, interest rate forecasts, currency forecasts and investment horizon.

Luminor uses public sources that it believes to be reliable. However, Luminor has not performed independent verification. Luminor makes no guarantee, representation or warranty as to their accuracy or completeness. All investments entail a risk and may result in both profits and losses.

This Marketing Communication constitutes neither a solicitation of an offer nor a prospectus in the sense of applicable laws. An investment decision in respect of a financial instrument, a financial product or an investment (all hereinafter “product”) must be made on the basis of an approved, published prospectus or the complete documentation for such a product in question, and not on the basis of this document. Neither this document nor any of its components shall form the basis for any kind of contract or commitment whatsoever. This document is not a substitute for the necessary advice on the purchase or sale of a financial instrument, a financial product.

No Advice

This Marketing Communication has been prepared by Luminor PMU as general information and shall not be construed as the sole basis for an investment decision. It is not intended as a personal recommendation of particular financial instruments or strategies. Luminor accepts no liability for the use of the Marketing Communication content by its recipients.

If this Marketing Communication contains recommendations, those recommendations shall not be considered as an objective or independent explanation of the matters discussed herein. This document does not constitute personal investment advice or take into account the individual financial circumstances or objectives of the persons who receive it. The securities or other financial instruments discussed herein may not be suitable for all investors. The investor bears all risk of loss in connection with an investment. Luminor recommends that investors independently evaluate each issuer, security or instrument discussed herein and consult any independent advisors if they believe it necessary.

The information contained in this document also does not constitute advice on the tax consequences of making any particular investment decision. The estimates of costs and charges related to specific investment products are not provided therein. Each investor shall make his/her own appraisal of the tax and other financial advantages and disadvantages of his/her investment.
 
Risk information

The risk of investing in certain financial instruments including those mentioned in this document, is generally high, as their market value is exposed to many different factors. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). The information herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of future results. When investing in individual financial instruments the investor may lose all or part of their investments.

Important disclosures of risks regarding investment products and investment services are available here

Conflicts of interest

To avoid occurrence of potential conflicts of interest as well as to manage personal account dealing and / or insider trading, the employees of Luminor are subject to internal rules on sound ethical conduct, management of inside information, handling of unpublished research material and personal account dealing. The internal rules have been prepared in accordance with applicable legislation and relevant industry standards. Luminor’s Remuneration Policy establishes no link between revenues from capital markets activity and remuneration of individual employees.

The availability of this Marketing Communication is not associated with the amount of executed transactions or volume thereof.

This material has been prepared following the Luminor Conflict of Interest Policy, which may be viewed here
 
Distribution

This Marketing Communication may not be transmitted to, or distributed within, the United States of America or Canada or their respective territories or possessions, nor may it be distributed to any U.S. person or any person resident in Canada. The document may not be duplicated, reproduced and(or) distributed without Luminor’s prior written consent.