Markets are really starting to worry now. Most global markets, including the US, are now into “correction” territory. That’s a fall of 10% or more. When we get to 20%, that’s a bear market. (These aren’t official definitions, by the way, they’re just guidelines that everyone basically agrees on.)
The question is: is it just stocks falling that we need to worry about? Or are there other areas that might cause more problems?
“Buy the dip” is so last month
The market is now taking coronavirus seriously.
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People are no longer in “buy the dip” mode. There’s a sense of confusion. Maybe panic is a strong word (this doesn’t feel like “capitulation” yet), but investors certainly aren’t relaxed. The Vix index – a key measure of volatility – has spiked sharply as markets have slid.
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That said, some people clearly are panicking. Zoom Technologies, which has the ticker ZOOM, saw its shares rocket by more than half yesterday, because investors think that video conferencing will benefit from coronavirus.
Thing is, there is a company called Zoom that does video conferencing, and it is listed, and it probably is fair to say that video and remote conferencing will benefit from coronavirus. But the video conferencing Zoom has the ticker ZM. The other one – the one that spiked yesterday – is just some tiny China-based hardware company.
So much for market rationality and percent information.
Anyway, it makes sense that markets are getting worried. Before the coronavirus spread, it was logical to assume that it would end up blowing over the same way previous pandemic threats have blown over.
However, coronavirus appears to have characteristics that make it easier to spread than those outbreaks. It has a high mortality rate relative to flu, but most cases are mild, so you have a lot of people wandering around unaware that they have it.
So I’m struggling to see how it ends up being contained. So, alongside the economic impact of China shutting down for at least a month, we also have the economic impact of Europe (at least) having similar issues. The travel industry is already hunkering down for an absolutely grim year.
So that’s where we are. What are the consequences?
Well, coronavirus could have a range of outcomes. On the very serious side, if you’re looking at actual shortages of goods due to supply chain disruption and production interruptions, then you’d potentially be looking at stagflation, which is a very nasty situation.
On the other hand, it might be temporary. I’m hearing a lot of reports that China is getting back to work. They might have simply given up on containing the disease, which might be bad for the people who catch it, but perhaps enable the economy to get back to normal relatively quickly. So there might even be a V-shaped recovery.
Corporate bonds are worth keeping an eye on
However, this is not a cheap market. And I’m not just talking about stocks (which have of course taken a bit of a knock in recent days). Corporate bonds aren’t cheap either. More to the point, a record proportion of corporate bonds are on the very lowest credit ratings you can get while still being investment grade.
As CNBC reports, the OECD notes that there’s a record amount of outstanding corporate debt (roughly $13.5trn of the stuff as of the end of 2019).
Meanwhile, “today’s trove of outstanding corporate bonds is of lower overall credit quality, with higher payback requirements, longer maturities and weaker investor protection.”
If we get a big enough shock to global supply and demand to damage profits over a longer period of time, then a fair few of those bonds could end up being downgraded. If that happens, a lot of them will have to be sold (as some fund managers can only own bonds if they are investment grade).
In a recent piece for the FT, not directly related to coronavirus, Joe Rennison notes that “weakness in the economy could coincide with a rash of cuts in credit ratings, amplifying a market sell-off”.
It’d be interesting to see how the market coped with that, particularly given the rise of passive investing in bond markets. Liquidity could become an issue at that point if everyone is racing to get out and no one is interested in getting in.
Meanwhile, with the oil price crashing, you have to wonder how all those oil-producer junk bonds at the bottom end of the market will cope.
We ain’t seen nothing yet
Then again – I think that we might be being too quick to write off the power and determination of central banks and governments. “Never let a good crisis go to waste”, as many a wise man has been quoted as saying.
A scheme has been launched to give permanent residents in Hong Kong a $10,000 cash handout. It doesn’t kick in until the start of the summer, but it indicates the potential direction of travel.
Why couldn’t Donald Trump do the same? Call it corona-QE. A temporary emergency stimulus. Or do it via a massive “temporary" tax cut and fund it with QE. Seriously, the sky is the limit. We ain’t seen nothing yet.
Of course, the market might have to fall further to get us there. Stick with gold, hold tight to your plan, monitor your watchlist – oh, and don’t type the wrong stock ticker in if you decide to buy something on the spur of the moment.
