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Markets crash on realisation of Covid-19 economic impact

1st Mar 20 7:15 am

What a week!  Having warned of the potential impact a global coronavirus pandemic could have last month, even I am shell-shocked by the speed and ferocity of the market decline we have just experienced.  Global equity markets are down more than 10% in the final week of the month, a move not seen since the 2008 financial crisis.

The trigger for the selling came last weekend when news broke that the cases of COVID-19 in Italy, South Korea and Iran were becoming large enough that public events were being cancelled and cities being quarantined.  Finally we had evidence it had got out of China and could be spreading quickly all over the world.

As the various healthcare officials now plan their containment measures, it is clear that there will be significant economic impact as global supply chains get disrupted, people postpone travelling abroad and affected cities go into shutdown as we already saw in China.  Unable to ignore the facts any longer, investors panic sold out of their equity exposures in favour of treasury bonds which had huge rallies last week taking yields back to all time lows.

This move in rates markets has now started to price in some kind of emergency response from central banks to cushion some of the negative impact to the economy.  Chairman Powell’s statement on Friday tried to reassure markets that they were monitoring the situation closely and will act as necessary.

Trump also mentioned potential tax cuts and other emergency measures to arrest the economic fears spreading through the economy.   The repricing in interest rate expectations has also weighed on USD which has pulled back 2% after attempting to breakout to the upside.  On continued weakness we would anticipate the USD to catch its safe haven bid once again.

Along with bonds, other safe haven assets such as Gold and Silver had been doing well until Friday.   Similar to moves we saw in 2008, most likely driven by people forced to close even their profitable positions to pay for margin calls elsewhere, precious metals gave back their entire month of gains in just one day.

This type of liquidation move is quite rare and may provide a good entry point for those with ammunition to buy.  Whether things get better or worse, I believe there is a strong case to hold Gold in you portfolio.  Other commodities that have been badly impacted by the global growth scare are Oil and Copper which are both down around 15% since mid January.

As tempting as it is to buy the dip here in risk assets given recent history, I feel that the nature of this crisis makes it quite difficult for the usual suspects to bail the market out quite so easily with cheap money and rate cuts.  This is not a demand side problem, it’s a supply shock.  If factories shut down because people are too sick to work, then goods don’t make it to the shelves, it’s not that people don’t want to buy them.

The current policy tools of interest rate or tax cuts won’t change the supply problem and hence may have little success in arresting the crisis.  Once they realise the ineffectiveness of policy tools to support the market, authorities may be forced to try short-selling bans (as was tried in 2008) which may induce violent rallies to squeeze the shorts.   Volatility is likely to remain high throughout March and with it comes opportunity for those who remain disciplined and open minded.

Written by, Imran Lakha, Senior Advisor, Vanguard Capital AG & CEO and Founder of Options Insight, Financial Markets Training.

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