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Monetary and fiscal stimulus have usually led to a v-shaped recovery

  • Monday, March 2, 2020

When the Corona virus initially took hold in China, rational investment considerations were based on past experience that similar pandemics do not leave lasting damage and have not historically caused lasting recessionary periods. On the contrary, history tells us that monetary and fiscal stimulus counter measures have usually led to a v-shaped recovery, once the warmer and dryer weather of spring brings the annual flu season to its natural end. However, once there was an increasing count of confirmed cases in South Korea, Iran and Italy, investor sentiment flipped, as less rationally inclined investors headed for the exit, creating a downdraft momentum that due to algorithm directed stop loss selling is still in full swing.

Stock markets were vulnerable to sudden, crash-like corrections because we had entered this difficult period with already quite extended stock market valuations following a very prolonged bull market and economic cycle.

That said, it is also worth noting that not much has changed factually since last week. China, the epicentre of the virus outbreak is reporting a steady decline in new infections and the country is returning to work this week. Both improvements reflected in positivity in the Chinese stock markets.
As the virus has turned from an economic hindrance to a personal and daily life changing threat, its impact on collective investor behaviour has become far harder to gauge and forecast. During violent market movements as we have experienced, the least potential damage comes from as little action as possible, given the propensity of wild swings between under-reaction to over-reaction.

The offsetting elements include a global economy on a fairly durable footing, central banks that remain supportive to counter credit market deterioration and governments at the ready to provide fiscal support should it be required.

Today share prices in Asia have risen after Japan’s central bank promised to help protect markets from the impact of the coronavirus. On Friday the US Federal Reserve made a similar pledge to stop more big falls on the world’s financial markets.

In a rare emergency statement, Bank of Japan (BOJ) Governor Haruhiko Kuroda said the central bank would take necessary steps to stabilise financial markets: “Overseas and domestic financial markets continue to make unstable movements due to heightening uncertainty over the impact on the economy from the spread of the coronavirus.” “The BOJ will monitor developments carefully, and strive to stabilise markets and offer sufficient liquidity via market operations and asset purchases,” he added.

The language used in the announcement suggested the central bank is ready to make full use of its existing tools to inject funds into the market, before considering what other steps it may take.

It follows a similar unscheduled announcement by the chairman of the US Federal Reserve. On Friday Jerome Powell said the central bank is watching developments closely for risks to the US economy and promised to take action if necessary.

Markets in the UK and Europe followed suit and have also risen in value.

If the spread of the pandemic is indeed already on the decline – as the figures from China indicate – and/or the Western world can deal with infections more effectively because of the one month warning our health systems received, then there is the possibility that this pandemic will follow the same relatively benign path for the economy as previous ones. On the other hand, much will depend on how much reduction in public and social activity will be necessary to contain the further spreading enough to defuse and restrain the public health impact of the virus. Should it become necessary to escalate such measures to levels China imposed over weeks then this could constitute a significant enough inactivity shock to the global economy to become the catalyst that ends this longest cycle in recent history – even despite all of the potential countermeasures aforementioned. While we will be actively monitoring markets, due to the falls of last week now starting to be reversed, we are inclined to see this through and not miss the valuation recovery when it comes.

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Chris Davies

Chris Davies

Chartered Financial Adviser

Chris is a Chartered Independent Financial Adviser and leads the investment team.

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