Last week was a tough one for markets. It appears that this week is starting with a rebound. As I write, Chinese indices are bouncing, and Asia is doing the same.
Perhaps it’s no wonder. We’re already seeing signs that central banks and governments are willing to wheel out the big guns. So is that it for the panic?
Can central bank and government intervention help with coronavirus?
On Friday, US markets were sliding. So the Federal Reserve, America’s central bank, popped up to announce that it was considering cutting interest rates due to “evolving risks”. Given that the next US interest rate meeting is in the middle of March, that suggests we’ll see a cut, and possibly a big one.
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Then, at the weekend, the Italian government said it would inject €3.6bn into the economy to mitigate the effect of coronavirus disruption. This comes on top of the near-€1bn announced on Friday for the hardest-hit areas.
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Part of the plan is to introduce tax credits for companies that suffer a 25% drop in revenues. How that will be measured and how quickly the money will appear is another matter.
Bear in mind that, only a year or so ago, people were fretting about Italy and the wider eurozone coming to blows over Italy’s budget deficit. I would be very surprised if that is still seen as any sort of issue now.
Indeed, Italy – with its willingness to spend – may soon be viewed as the model eurozone country, given that the European Central Bank keeps nagging governments to spend more cash.
So it’s clear that governments are more than happy to spend and central banks to cut, in order to “help out” here.
Will that work? Let’s have a think. I’m going to keep this simple – probably too simple – but you’ll get the point.
Two things matter in an economy: supply and demand
We have grown used to a world where supply is pretty much always plentiful. The thing that policymakers have always worried about is demand. 2008 was seen as a “demand” shock. People and companies couldn’t get credit. So they couldn’t buy stuff. So the solution was to make it easier for people to access money in order to boost demand.
Coronavirus definitely represents a demand shock. If people are sick, they won’t be out consuming. If people don’t get paid because they can’t work because they are sick (which is the case in some parts of the world), then they won’t be out consuming.
Probably most important from an economic point of view, if people are worried about getting sick, then they won’t be going out and about, and they won’t be buying as much stuff. (And then there are all the closures of public gatherings and all the rest of it.)
So that’s your demand shock right there. Making credit cheaper and giving people money won’t stop people worrying about getting sick, but it can certainly alleviate the shock. (Or, if it’s done via quantitative easing, then the money will just go into asset prices because there’s nowhere else for it to go.)
We’re not used to worrying about the supply side
But there’s the supply side shock, too. The issue here is that if people are too sick to work then they can’t produce the goods and services that people are demanding.
And if supply chains are demolished then companies can’t get their goods to market. And if companies go bust because they were too heavily indebted already and this pushes them over the edge, then capacity is wiped out.
In turn, if we run out of supply, then prices go up. We end up with stagflation. It’s a bit like the oil shock of the 1970s: demand remains plentiful, but the goods aren’t there to go around.
From that point of view, there’s not much that a central bank can do to address the supply side. That’s more of a government action thing and even then, it’s more complicated than “oh just pump more money into the economy.”
The question then is: how bad will each of these shocks get? I don’t know (obviously) how bad the coronavirus will get. We seem to be moving from “it’ll be contained” to “it’ll end up being endemic but it will hopefully burn out in summer and it mostly kills old people”.
This is why a lot of the discussion now is coming down to: how do we balance the economic risk of aggressive containment (closing everything down) – which is a gamble, because it might not work anyway – with the economic risk of the pandemic being worse than everyone expects? That’s really hard for markets to discount because we really don’t know.
China looks as if it has decided to get everyone back to work. But it’s hard to trust the data from China – I was reading something this morning which suggested that factories are running machinery even if no one is able to work or produce goods because they’ve been given electricity consumption targets.
I’d have more confidence if the epidemic in South Korea starts to calm down. Or the one in Italy. The data is still hard to gather but at least you know that the respective governments don’t have any real incentive to present a more optimistic view than is justified.
So where does that leave investors?
Look, I’ve got to be honest, I looked at my “fun” portfolio at the weekend (that’s where I buy individual stocks rather than the relatively dull stuff in my pension fund) to get an idea of the damage, and I was very tempted to top up on a few things.
On the one hand, that feels foolhardy. On the other hand, although I keep pointing out that governments want to spend and central banks want to cut, that’s not the rationale behind the individual stocks I own (which comprises a lot of UK domestic stuff at the moment).
I mostly own stocks because they were already inexpensive. And how hard a hit will the UK economy have to take from coronavirus to justify a double-digit drop from what are often cheap valuations in the first place?
What’s my conclusion? I think that headline risk points to this being a temporary lull. It’s clearly spreading in the US, slowly but surely. And while I like to hope we’ll be spared, realistically it can only be a matter of time before it’s picking up pace in the UK.
So I’m hanging back for the moment. But I really would recommend that if you don’t already have a watchlist, you make a bit of time to build one.
