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The worst is probably not over for sharemarkets

Donald Trump’s comments that he wants the US economy to re-open and “just raring to go” by Easter – even as the number of Americans infected and the total number of deaths in the US keeps climbing – may also have been a factor.

Even in a bear market big swings in the market are not unusual. That bounce in October 2008 occurred within a market that fell about 60 per cent from its peak in October 2007 to its nadir in 2009 – the worst of the decline was yet to come.

In an environment where there is as much fear and uncertainty as there is at present, exaggerated movements in financial markets are, in fact, to be expected.

The most notable feature of all financial markets in recent weeks has been the rush by investors to cash out every risk asset that they can, with the safest assets – even US Treasury bonds – being sold off as brutally as the riskier investments because they are the most liquid and therefore the easiest to liquidate.

The reason the US Federal Reserve decided to embark on its unprecedented and open-ended program to provide liquidity and credit to the US financial markets this week was precisely because it feared the seizing up of liquidity in the markets would precipitate a financial crisis with dire economic consequences.

In markets where there is little liquidity any buying or selling has an exaggerated impact on prices, whether they are rising or falling. Bid-ask spreads in the US stock market have blown out and volatility, while it has fallen back from its levels last week, remains at historically high levels.

That there is any buying at all in this market might raise some eyebrows.

Why would anyone buy amidst this level of uncertainty?

Some of the activity will be “short-covering” – investors have sold stocks they don’t own in expectation that their price will fall and they can then buy the shares at the lower price, generating a profit.

Some will be from punters “buying the dip.”

In the panic selling we’ve seen in recent weeks the selling is indiscriminate. Some companies – like supermarkets, or technology companies and retailers, or social media companies – are benefitting from the pandemic and the actions governments have taken to try to contain it. They may, or may not, represent bargains in this environment.

Others, with deep pockets and long time-horizons, may take the view that regardless of how long the bear market lasts, and no matter how much further the market might fall, they can hold onto the stocks until the inevitable bottoming of the market and the anticipated surge that will occur once that occurs.

The reality of the current market circumstance is that those circumstances are unprecedented. This is not 2007, or 2000, or 2008. It’s a health crisis, an economic crisis and a financial crisis rolled into one, with the dimensions of each of those crises, and the impacts of their interaction, unknown and incalculable.

It is clear that the impact of the pandemic in the near term, as swathes of activity within economies are shut down by government decree, will be immensely destructive of economic activity and individuals’ circumstances.

Unemployment will soar, as will corporate collapses and bankruptcies, despite the unprecedented efforts by governments and central banks to minimise the damage to the economy, businesses and individuals.

Overnight there was a slew of indices of factory and service activity in the major economies. All have dived to financial crisis levels or, in Europe, to levels never previously recorded.

The effects will be far worse for businesses and households than the deep recession we had in the early 1990s and some of those effects will linger long after the virus is contained.

The US markets, or at least some within them, may have responded enthusiastically to the Fed’s big splurge and the prospect of the $US2 trillion ($3.4 trillion) “stimulus” package but the pandemic represents a solvency shock for business of all shapes and sizes and households and economies.

The “stimulus” in the US, the UK, Europe and here isn’t about stimulating economies as much as it is about ensuring there’s something left when the pandemic has finally run its course.

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The actions taken by central banks might keep financial systems operating but access to cheap credit doesn’t mean much for businesses that have no income or prospects of re-opening in the near term.

Until it is apparent that the pandemic has peaked and is contained the markets will remain volatile and potentially wealth-destroying for the over-optimistic.

It’s improbable that markets have bottomed. Indeed, until it is apparent the pandemic has run its course, there probably is no bottom.

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