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People are reflected in a window of the Australian Securities Exchange in Sydney on March 17. Asian markets have fluctuated after Wall Street suffered its worst day in more than three decades with coronavirus panic sweeping the globe. Photo: AFP
Opinion
Hannah Anderson
Hannah Anderson

The coronavirus has created an unprecedented market environment. Do the usual rules still apply?

  • To cushion the impact of social distancing, fiscal stimulus will have to go way beyond its current level of slightly over 1 per cent of global GDP
  • The current volatility is a reminder that investment strategies matter when it comes to how portfolios behave during a rapid market downturn

Fears related to the global spread of Covid-19 continue to grip markets. Several economies are at a standstill, volatility reigns and a general sense of unease permeates almost every corner of our lives. Such are the consequences of a public health crisis which precipitates an economic downturn.

These two together plus the additional issue of problems in the world’s financial plumbing and doubts about the effectiveness of several governments at containing the spread of the disease have pushed uncertainty to all-time highs.

Uncertain investors are prone to make mistakes. We can all repeat the “be disciplined and stay invested” mantra to ourselves as many times as we want, but that doesn’t change the fact that we are living through a market environment without precedent. It is reasonable to ask if the rules still apply.

To help sort through the constant influx of news, I address five questions: How has this disease progressed? What will be the economic impact of its progress and measures to contain it? How effective will monetary and fiscal policy changes be at mitigating these effects? How will markets respond? And, what would a rational and disciplined investment strategy look like?

First, with the caveat that very few of us are public health officials, the virus does seem to follow a pattern in each country. The number of cases increases exponentially until each country embraces widespread testing and social distancing. While some countries have implemented these measures more rapidly than others, it does suggest that the Covid-19 epidemic will be brought under control.

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Secondly, while measures like social distancing are effective, they do come at an economic cost. Unquestionably, this economic cost pales in comparison to the human toll of an unchecked outbreak. But for those of us who would rather fret about the economy than about when we last washed our hands, it does seem likely that the global economy will enter a recession in the second quarter.
Measures to cushion this fallout – emergency rate cuts and bond buying by central banks, plus fiscal stimulus by many governments – will be expensive, but may mitigate some of the worst economic fallout. It is unlikely that stimulus measures announced so far will prevent a recession, but it will help the global economy rebound in the later part of the year.

It’s a tough pill to swallow, but central banks cannot do all the heavy lifting on their own. They can lower funding costs for banks and businesses. They can make lending easier and more attractive for financial institutions. They can be the lenders of last resort and guardians of liquidity. However, they cannot create demand out of thin air.

A man checks his phone at an empty Apple flagship store on Fifth Avenue in Manhattan, New York, on March 14. Fiscal stimulus is a way for governments to encourage demand. Photo: AFP
Fiscal stimulus is demand-generating. A pandemic is a unique economic shock because it cuts into both demand and supply. The low-borrowing-cost environment central banks create can make demand-generating fiscal spending cheaper for governments.

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So far, governments have shown a willingness to spend. But, they haven’t been willing to spend much. The fiscal input of measures announced so far globally amounts to just north of 1 per cent of global gross domestic product. The GDP hit from coronavirus-related measures could well stretch into the double digits (on an annualised basis).

Something is better than nothing, but mitigation of the costs of social distancing will require more drastic action on the part of governments.

A tourist poses in an almost empty mall in the centre of Milan on February 28. The country has been hit hard by the Covid-19 outbreak and resorted to declaring a national quarantine. Photo: AFP
On the fourth question, markets have already priced in a recession. Core government bond yields sit at records lows and equity markets have sold off broadly. Complicated by financial plumbing issues, investors are demanding liquidity above all.

This need for assurance that they will be able to exit positions quickly and the desire to hold large amounts of cash has revealed stress points in the financial system. Some of the emergency measures announced by central banks are an effort to shore up these areas and may prompt regulatory changes soon.

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At the very least, such rapid changes in market behaviour have forced us to remember that our investment strategies always need to account for how portfolios will behave during a rapid downturn in markets. Portfolios need to be built to achieve investment goals. And one of those goals should be to withstand a market downturn.

When the world emerges from this pandemic, which will happen eventually, investors who were prepared for market disruptions are likely to be in a better position to benefit from the recovery than those who panicked. The depth and duration of this market sell-off will be determined by a large number of factors, most importantly the progress of the Covid-19 infection.

Hannah Anderson is a global market strategist at JP Morgan Asset Management

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This article appeared in the South China Morning Post print edition as: Time for strategy rethink amid unprecedented market conditions
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