No telling where markets will end but controlling the virus is the beginning

After 30% plus falls from their highs earlier this year, share markets had a welcome rebound over the last week.

7 March 2020 | Shane Oliver, AMP Capital (Image: John Cameron)

While the number of coronavirus cases continues to soar and economic data beyond China is now showing the huge impact from the shutdowns, share markets managed to rebound because a lot of bad news had already been factored in and government and central bank stimulus measures are now reaching a critical mass in terms of limiting the economic impact of the shutdowns.

Shares fell on Friday as the EU didn’t reach agreement on a joint fiscal response to the virus and the Fed said it would scale back its bond buying a bit (which looks more like fine tuning given bond yields have fallen, than the Fed reducing support).

Despite this US shares rose 10.3% for the week which was their strongest week since March 2009, Eurozone shares rose 6.5%, Japanese shares gained 17.1%, Chinese shares rose 1.6% and Australian shares gained 0.5%.

Bond yields fell helped by central banks’ bond buying programs, particularly in Italy. Oil and iron ore prices fell. The $US fell back sharply on the back of unlimited Fed quantitative easing which saw the $A bounce back to around $US0.6150.

Spread of coronavirus and economic impact of shutdowns remains bleak

First, new cases outside China are continuing to surge, with Europe leading the rise (53% of coronavirus cases are in the European Union) but the US is likely to see a rapid rise in the weeks ahead as the number of tests increases.

Italy, Switzerland, Spain, Austria and Norway are looking bad after adjusting for population. But the US and Australia are continuing to climb too.

Second, the mortality rate has continued to edge higher and is now 4.5%, thanks to a surge above 10% in Italy and to above 7% in Iran and Spain. The basic problem in Italy is that its hospitals have been overwhelmed, highlighting the need for aggressive social distancing elsewhere in order to avoid the same fate.

Third, reflecting this, social distancing has intensified globally and in Australia. Nearly 60% of 41 major countries have severe restrictions on mobility in place compared to around 5% prior to 10th March. Even China has now closed its border to foreigners to stop importing coronavirus cases.

Finally, the lockdowns are resulting in a huge hit to economic activity. This was already evident in China in February and over the last week has become clearly evident in developed countries with business conditions PMIs falling to below levels seen in the GFC and US jobless claims rising by a record 3.3 million. Similarly, sharp falls in business conditions PMIs occurred in Australia.

Some snippets of light at the end of the tunnel

First, after circa 35% falls share markets have already factored in a sharp contraction in economic activity and with everybody gloomy were able to have a decent bounce, despite horrible economic data.

Second, Italy has seen the number of new cases trend sideways to down slightly for six days, suggesting its lock down from 9th March may be working, albeit it’s too early to get too excited. Out of interest it may be following a similar pattern to China with a rough lag of 10 to 20 days between the lockdown and the peak in new cases. Following the Chinese experience some relaxation of the lockdown may be possible in a month or so. If Italy can get it under control, then it’s a positive sign for the rest of us.

Third, the Chinese economy is gradually returning to normal with daily activity indicators for traffic congestion, subway use, coal demand at power stations and property sales continuing to trend up. Reflecting this Nike announced that 80% of its stores in China have reopened. Of course, China will be impacted by less demand for its goods from the rest of the world.

Fourth, policy stimulus has continued to ramp up dramatically, providing some offset to the economic shock from the virus and its impact on financial markets. Notably in the last week:

  • The Fed has moved to open ended quantitative easing (QE) and expanded its array of lending programs to provide assistance to various borrowers including commercial real estate, consumers and businesses, corporate bonds and municipal finance.
  • $454bn US Federal guarantee of loans as part of the US spending package will enable the Fed to gear up to around 10 times that in Fed loans representing a massive injection of cash into the US economy.
  • The latest US spending package is now $US2 trillion or 9% of GDP and includes loans, loan guarantees, tax concessions, an extension and increase in unemployment benefits (by $600 a week), payments to business and payments to individuals. Taken with Fed action its likely to help businesses hold off from laying workers off. The package has now passed Congress and has been signed into law.
  • The ECB dropped its limits on how many and whose bonds it can buy under its QE program, filling the gap as the EU only slowly moves towards some sort of joint fiscal response to the virus (likely using the European Stability Mechanism or joint coronabonds) and this along with other measures has seen Italian 10 year bond yields fall from 2.4% a week or so ago to around 1.3% which is near pre crisis lows.
  • The RBNZ announced QE and the NZ Government ramped up its wage subsidy program and is moving towards a guaranteed lending to businesses and support for mortgage holders.
  • Singapore boosted its stimulus package to around 11% of GDP.
  • India announced a stimulus plan and cut interest rates by 0.75%.
  • G20 leaders committed to doing “whatever it takes” to control the virus and limit its economic hit – this is mainly symbolic given they were mostly doing that anyway..but still!

A big hit but not the Great Depression

The hit to GDP across Europe, the US and Australia which could be as bad as 10% or so in the June quarter and jobs may look like a depression but the policy response is way different to what was seen in the last depression in the 1930s, where the initial response was policy tightening.

There have now been more than 240 stimulus announcements around the world. Central banks and governments are clearly committed to doing “whatever it takes” to limit the economic impact on the economy and ensure a decent recovery. The next chart shows our estimate of global fiscal stimulus as a share of GDP over the year ahead. If currently proposed measures are allowed for it will be over 3%of global GDP and far greater than that seen in the GFC.

These measures will help minimise the downside and boost the recovery, but we still need to see evidence that the virus and its economic impact will come under control before we can be confident that shares have bottomed. Shares have had a very strong bounce in the last week, but we saw similar rebounds in the GFC before shares ultimately bottomed. 

Dr Shane Oliver is Head of Investment Strategy and Chief Economist, AMP Capital