It has been a very volatile week in markets as fears over the economic impact of the Coronavirus have risen as the number of new infections has escalated, leading to governments taking more draconian measures to get it under control. What is clear is that markets are not content with central bank action, despite it being immediate and large in scale. The shutdown of economies is going to heavily impact jobs and companies and therefore governments need to step into the void, and until they do so, prices will remain under pressure. Towards the end of this week, as more governments have stepped forward promising action, there has been some stabilisation in markets. However, it is one thing promising action and another delivering on it.
US equities experience their single largest day loss since the crash of October 1987
As of 12pm London time on Friday, US equities are down 11.1%, however, in Sterling terms, US equities are down 5.5%, as the US dollar appreciated dramatically against most currencies amidst a dollar funding squeeze. European equities are down 1.6% over the week, although in Sterling terms, they have actually risen 0.4% as Sterling came under pressure against most major currencies this week. UK equities have fallen 4.1%, with most of the pain being experienced within mid and small cap companies, with the UK mid cap index falling 11.7% versus 1.9% for large cap companies. Japanese equities rose 1.7% as the Bank of Japan announced that it would double its purchases of Japanese equities through exchange traded funds to 12 trillion Yen a year, equivalent to $112 billion. The Japanese market was further boosted by rising expectations for fiscal support from the Japanese government. However, for Australian equities, exposed to financial and mining stocks, the market fell 13.1% over the week. Emerging markets dropped 14%, with China and Hong Kong remaining relatively defensive, falling 4.9% and 5.1% respectively. India fell 12.3% and Brazil lost 17.4%, with the latter being hit particularly badly from a further collapse in the oil price during the week.
Few places to hide
It was also a difficult week for defensive assets, despite the Federal Reserve enacting an emergency interest rate cut of 1% on Sunday, taking rates to a range of 0% to 0.25%. The stress came from a US dollar squeeze, as demand spiked from countries and companies funded in dollars to keep themselves financed. This culminated in liquidity drying up, as investors increasingly turned to their most liquid assets as cash was required, leading to a selloff in government bonds and, once again, gold. Yields, which move inversely to price, on 10-year US Treasuries rose to a peak of 1.26% on Thursday, having traded as low as 0.65% at the beginning of the week, whilst UK Gilts went from a yield of 0.40% to 1.01%, and German bunds swung from minus 0.58% to minus 0.15% over the same period. The government bond market started to behave more normally as the US Federal Reserve announced on Thursday that it would open up US dollar swap lines with more central banks globally. This coincided with the Bank of England cutting interest rates to 0.1% and expanding its bond buying programme by £200bn, and the European Central Bank announcing a plan to buy $750bn of bonds. This led to government bonds rallying, with 10-year yields on US Treasuries falling to 1.01% by Friday, with German Bunds trading at minus 0.28% and UK Gilts 0.58%. Similarly, the gold price fell from $1,560 an ounce on Monday, to $1,451 at its lowest point on the same day, before clawing back some of those losses during wild durations over the remainder of the week, and now currently trading at $1,507 an ounce.
Wild swings in the oil price
Amidst the economic hit from the coronavirus, the oil price took a second leg down this week, falling over 25% by Wednesday, with Brent crude trading as low as $24.5 a barrel and US WTI (West Texas Intermediate) trading down to $20.1 a barrel. As governments increasingly came out pledging fiscal action, there was a strong bounce back on Thursday, with WTI rising by 25% to $25.3 a barrel, its biggest one-day gain on record. Brent is currently trading at $29.2, and WTI $25.6 a barrel, however, pricing remains very volatile.
Issues under discussion
Our expectation remains that this is likely to be a short sharp crisis, however, as things stand today, it has the potential to result in a severe recession. However, if governments step in to support their economies through fiscal stimulus and helicopter money, the idea of giving your population money (the reverse of collecting taxes), the worst of the crisis could be avoided. Until governments deliver on this, which is increasingly expected, and a peak in new infections is reached, volatility in markets is expected to continue.
Sterling came under pressure this week, from a combination of a dollar squeeze and the UK economy running a large current account deficit with a heavy reliance on the financial services industry. Sterling, which at the end of February was trading at over USD1.30 and EUR 1.18, collapsed to beneath USD1.15 and close to EUR1.05. For sterling investors this has had the benefit of shielding investors from some of the most extreme losses when holding overseas assets. With Sterling having fallen to a level substantially lower versus the US dollar than during the height of Brexit concerns, and with the knowledge that historically when there has been a dollar funding squeeze that the Fed has stepped in to ease liquidity pressures, we considered it prudent to partially hedge out some of this currency exposure should it snap back. However, we would not want to have an outright short on the US dollar, recognising that the situation has the potential to get worse before it gets better.
Within our portfolios, we have hedged half our overseas currency exposure in US, European and Japanese equities back into Sterling.