If you are wondering just how bad the pandemic needs to be to justify c30% falls in share prices across all major markets, you are not alone. Our ‘finger in the air’ judgement is that markets are discounting a complete wipe out of corporate profits for, maybe, the next three years. Or, coming at it from a different angle, a reduction in the global population of, perhaps, 10% – with all the accompanying economic dislocation and damage that would entail. Serious though the pandemic is, to us this appears out of all proportion to the evidence and experience we have seen to date. So, what on earth is going on?
To say this is not all about coronavirus is slightly mischievous. But to our mind the dreaded covid-19 is just the latest catalyst for financial markets to do what they are prone to do with irritating regularity. As soon as a ‘risk off’ event triggers selling, financial markets dislocate. This time it was the US government bond market that set alarm bells ringing by becoming dysfunctional. This is particularly scary, as the $18tn US sovereign debt market is supposed to be among the most liquid in the world, setting reference interest rates for any number of securities, mortgages and other debt instruments around the world.
The dysfunction comes from the usual list of suspects: funds, investment bank proprietary trading desks and other dealers who make a living by trading in huge size for small but (almost) assured profits. When the catalyst comes along, as it now has, and these traders need to close their positions there is insufficient liquidity to meet their sale orders. Specific markets go into freefall, with a vicious, self-reinforcing cycle of selling until everyone begins to wonder: how bad must coronavirus be? This is hugely destructive due to the impact on economic sentiment and the negative wealth effects.
Where does it end? With the authorities – central banks and governments stepping in to provide the liquidity to halt the vicious circle. On such occasions, financial markets, or to be fair corners thereof, might be likened to the child pyromaniac who time and again sets his parents’ house on fire. He knows his actions are dangerous to his own health but, importantly, he also knows that his parents and the authorities more widely will come along and put the fire out for him. This is because they have even more to lose than him. Hence, for whatever reason (in the case of financial market dealers that reason is always profit) he keeps doing it – and keeps getting away with it. Thus, we see the repeated efforts of the authorities to stop the ‘rot’ by cutting interest rates, injecting liquidity by buying securities from market participants desperate to close out positions.
It is important to note that we are not saying that the virus is not serious – or that it will not inflict a serious blow on the global economy. We are simply saying that investors should spend no time worrying about what markets are implying about coronavirus. This market correction is not all about coronavirus.
Heronsgate Capital LLP is an appointed representative of Dart Capital Ltd which is authorised and regulated by the Financial Conduct Authority registration number 137569. Heronsgate Capital LLP is a limited liability partnership registered in England and Wales with registration number OC430243 and registered office at 28 Queen Street, London, EC4R 1BB. This document does not constitute advice or a personal recommendation or take into account the particular investment objectives, financial situations or needs of individuals. This document is not intended for further distribution. This document has been prepared with all reasonable care and is not knowingly misleading in whole or in part. The information herein is obtained from sources which we consider to be reliable but its accuracy and completeness cannot be guaranteed. No responsibility is taken for any losses, including, without limitation, any consequential loss, which may be incurred by anyone acting on information in this document. The opinions and conclusions given are those of Heronsgate Capital LLP and are subject to change without notice. The value of investments and the income from them are not guaranteed and can fall as well as rise and clients may not get back their original investment. It should be remembered that past performance is not necessarily a guide to future performance. Where investments have particular tax features, these depend on the individual circumstances of each client and tax rules are subject to change in the future.
