A few weeks ago, investors were anticipating a “V-shaped recovery” in global growth, but they are now pricing in a high probability of negative growth.
The fears have dragged stocks, with markets now entering bear territory, having seen drawdowns of more than 20 per cent in recent weeks.
Paul O’Connor, head of multi-asset at Janus Henderson has said until there is evidence that COVID-19 has been contained internationally, markets are likely to remain volatile and vulnerable.
“The big question from here is whether this is the start of a more sustained decline or whether markets are already looking attractive, now that markets are pricing in fairly gloomy economic outcomes,” Mr O’Connor said.
“A meaningful recovery in risk appetite will probably require some confidence that the coronavirus is being contained. While good progress seems to have been made in this direction in China and South Korea in recent day, the accelerating spread of the virus in Europe and the US remains troubling.”
Similarly, Andrew Canobi, director of fixed income at Franklin Templeton Investments Australia has said a world recession is “quite possible” with Australia being vulnerable.
He noted bond markets were quick to sense the impact of the virus, with US 10-year Treasuries closing at 0.54 per cent on 9 March, down from 1.62 per cent in mid-February. Similarly, Australian bonds have hit record lows.
“We have written extensively in the past that this is the destination we felt we were on the path to,” Mr Canobi wrote in his analysis.
“We of course didn’t foresee a global pandemic accelerating the move in the first quarter of 2020.
“No one wants to see another financial crisis. Unfortunately the parlous stance of world finances and balance sheets [leaves] us in a vulnerable place.”
Global debt/GDP is at 242 per cent, compared to 211 per cent in 2007. Mr Canobi pointed to US corporate debt/GDP being at record levels, while Australian household debt/GDP is around its highest and second in the world.
“The risks remain of another deflationary shock at a time when the much-expected post-GFC deleveraging not only didn’t happen but went the other way,” Mr Canobi said.
Flavia Cheong, head of equities, Asia Pacific and Robert Gilhooly, senior emerging markets economist at Aberdeen Standard Investments noted the recent sharp drop in oil prices, saying while it has added to attractive valuations, there is more pain to come.
“We don’t think the market has yet priced in the worst-case scenarios, with overarching macro concerns likely to weigh on sentiment and share prices further,” they wrote.
“Of course, it’s difficult to predict how this COVID-19 situation will evolve, given uncertainty over the duration of the economic impact, extent of demand destruction and the shape of the recovery cycle. But it’s hard to see how all of this would be resolved quickly.
“The potential upside is that low oil prices will further tighten supply, which should make the macro outlook more positive at some point in future when demand improves and inventory levels are worked through. But in the short term we expect fear and volatility to persist. Still, fear in markets is traditionally a time for long-term investors to seek valuation entry points, as indiscriminate selling drags company prices away from their intrinsic value.”
Similarly, Mr O’Connor said, what will revive market sentiment in the short-term is far from obvious.
“Whereas central bank actions have been effective circuit breakers in many past market sell-offs, we see limited scope for game-changing monetary policy interventions today,” Mr O’Connor said.
“We expect central banks actions to remain focused on liquidity provision and keeping credit flowing through the financial system rather than trying to deliver big rate cuts or new quantitative easing programmes. Fiscal policy seems the best solution for the world economy’s current ails, but progress here so far has been reactive and piecemeal.”
In Australia, the government launched its battle plan to hold up the economy through the outbreak on Thursday, a $17.6 billion fiscal stimulus package. Economists however are sceptical it will keep the country from falling into a recession.
A number of experts are anticipating another 25 basis point (bp) rate cut from the RBA in April, following its decrease this month.
Overseas, Bank of England and the Bank of Canada have both cut by 50 bps, following the Fed’s emergency slash in the US last week.
“Very soon, most if not all central banks will reach their effective lower bound, 0 per cent in the case of the Federal Reserve,” Mr Canobi said.
“QE programs of various forms will follow. Fiscal stimulus will be delivered, and we expect it to be largely ineffective other than to marginally soften the blow.”
