Is the Global Economy Infected? Part II

Despite the world’s biggest central banks intentions to deliver monetary policy in order to soften COVID-19’s impact on the economy, markets continue to fall sharply in an irrational manner. On the last week of February, the major financial indexes showed startling results registering their biggest fall since 2008, with the S&P 500 dropping 11%, its worst weekly decline since the financial crisis,  the Dow Jones Industrial Average crashing 12.4% and the PSI-20, the main Portuguese index, registering its worst result since Brexit.

How are investors reacting?

A few stocks managed to escape the sentiment of fear by investors. Evidently biotech stocks, particularly the ones involved with the production of vaccines and antivirals, were one of the main class of stocks that rose in recent weeks. A particular example was Zoom, as investors are already pricing an expected period in which people will be forced to work from home and must use systems like the ones this company develops.

Investors quickly ran to the “safest” asset in the financial markets with US Government Bonds surging and dropping the 10-year US Treasury yields below 1%, an all-time low, also as a result of the interest rates cut by the Fed.

The yen is another traditional safe harbour being perceived as one of the most stable currencies amid market uncertainty and, at the time this article is being written, stands at 108.20 yen a dollar. Gold reached a seven-year high last week with investors using the precious metal as a haven from the meltdown in Wall Street. But, in these last few days, gold’s price plummeted with the biggest one-day decline since 2013. Gold dropped 4.5% on the 28th February as investors are selling it to cover margin calls as needs for cash arise due to the sell-off in stocks and fear is rising that China’s demand for gold is severely weakening.

However, ETF investors seem to be the exception in a week of pure panic in Wall Street. When we take a closer look at ETFs linked with the stock market indexes, we observe that the players that shifted higher amounts of cash from SPY have been institutional investors that are being faced with liquidity concerns, it was not a panic move. Another trend is the outflows from funds related to Japan who are in the frontline of the virus and shifts to European markets, for example. At the same time, with the decrease of interest rates and the continuous inversion of the yield curve, investors dumped financial ETFs like the XLF (an ETF that tracks an index of S&P 500 financial stocks) and again it was a very rational decision. Contrary to what is being seen in other markets, even amid uncertainty, there is still a strong demand for ETFs.

Short sellers on the US stock market, that predicted overvaluation and were expecting a period of correction, got a big help from the outbreak of the virus and managed to make $105 billion in a week. This has also prompted a raise in short selling since some believe the bottom has not yet been achieved.

Moreover, some of the world’s biggest enterprises are suffering at the hands of this illness. Dow Inc., Goldman Sachs Group and Intel, alongside Apple, were the sum of main victims as “24 of its 30 components finished in the red”. For instance, Apple expressed its concerns of not being able to fulfil its second-quarter financial guidance since the outbreak has led to a cut in the production of iPhones and the firm heavily depends on factories in Shenzhen, China, and its Chinese customers. Therefore, the American multinational technology enterprise joined the number of companies that are expected to reach the bottom line caused by this pandemic.

What are the main global institutions doing to fight the coronavirus’ economic and social shock?

Governments and Central Banks have been trying to stabilize the markets and diminish the economic effects of the virus before an increase in infection cases cause tougher impacts.

Central Bankers around the world are decreasing rates or acting to ensure liquidity in the financial markets. This support has been the cause for some rallies along these weeks, keeping investors hopeful that the effect of COVID-19 in the world economy will be diminished in some part. At the start of March, the Fed moved from hinting to making an emergency interest rate cut of half a percentage point, its biggest cut in more than 10 years. As of the 3rd of March, interest rates now sit between 1% and 1.25% as Jerome Powell states that the central bank is “prepared to use our tools and act appropriately, depending on the flow of events”. Despite this action, markets reacted negatively hinting that stimulus may make borrowing cheap, but the economic menaces come from a decrease in consumption and an infected workforce. Besides the Fed, the Reserve Bank of Australia has cut interest rates to 0.5% and the Bank of England and the Bank of Japan pledged to use every mechanism in their hands to “ensure all necessary steps are taken to protect financial and monetary stability.” Even the initially sceptical ECB joined other central banks in recognizing the threat and taking arms against it.

The People’s Bank of China was the first to cut its rates and the Chinese Government is expected to increase fiscal stimulus as worries about reaching its economic targets are surging. This fiscal stimulus will probably consist in investment in infrastructure to deter the slowing in economic activity shown in recent reports.

On the other side of the Atlantic, President Trump and the government’s health-care authorities have been releasing contradictory statements in what concerns the extent of the threat this pandemic represents. While the major figure of the United States disregards the impact of the virus, stating that the risk is low and assuring Americans that they’re unlikely to die from an infection, the CDC (Centre for Disease Control and Prevention) has publicly detailed that “an American outbreak would likely cause widespread disruptions in everyday life, including closed schools and cancelled business meetings”.

On the other hand, the Chinese power aggressively acted in order to slow the spread of COVID-19, establishing a Central Leadership Group for Epidemic Response and the Joint Prevention and Control Mechanism of the State Council. Moreover, the General Secretary Xi Jinping personally directed and deployed the prevention work, making the control of the COVID-19 outbreak the top priority of the government at all levels, closing schools and other public facilities, asking overseas Chinese to reconsider travel plans and advising citizens to quarantine. Nevertheless, the attempt to silence whistle-blowers distorts the real figures of the impact the virus has had on China.

What’s next for this pandemic?

Undoubtedly, if the virus continues to spread at this pace, its impacts will reach a greater dimension. Jobs are in danger and most firms’ supply chains are jeopardized, rocking financial markets and tumbling the global economy. Some believe the worst is yet to come. It is also important to remember that the American elections are taking place in November and may have a big impact on investors sentiments. We could see trade wars between China and the US worsening if Trump gets re-elected. The world economy is in a very tight deadlock and the next months will dictate its future outcome. Is this just a glimpse of what awaits us? Either way, not much is within our reach. So, let’s just wash our hands and wait as we watch 2020’s soap opera unfold.

Sources: Bloomberg Intelligence, Market Watch, The Washington Post, CNBC, Financial Times