Our latest views on global stock market volatility

This weekend’s breakdown in negotiations between OPEC (the Organisation of the Petroleum Exporting Countries) and Russia sent oil prices down 25% and has exacerbated the selling in equities. We have been watching the extreme market volatility with some concern and would like to offer our views.

Coronavirus developments

The COVID-19 virus has been dealt with differently in various parts of the world. Asia has probably been the most efficient, throwing massive amounts of testing at the problem and then isolating infected people. As a result, the death rates have been amongst the lowest in the world. South Korea has a death rate way below 1% of cases thanks to its testing blitz, disinfectant drive and excellent healthcare system. Singapore has yet to see a single death despite 160 cases. Some of the activities undertaken in Asia may not be applicable in the West, such as the lockdown of a whole province in China and the total ban on people’s movements. Yet in China, the number of new cases is now falling and many regions are now back to normal with no new cases at all.

At the other extreme, we see the US, where the Trump administration’s policy is more hands-off than in Asia, with limited testing for a variety of reasons (test kits not ready, patients have to pay, no government drive to encourage testing). It seems as though President Trump is making the bet that the economic fallout from the virus is worse if you try to contain it. As he is facing an election in November, the state of the US economy between now and then is of crucial importance to his re-election chances.

Europe (and the UK, to an extent) seems to have gone for a medley of steps (closing schools, banning large public meetings, panic buying and stockpiling). The jury is still out as to whether these measures will work, but right now the markets are punishing these countries the most, meaning they don’t trust the combination of policies to tackle the virus.

How markets are reacting

This leaves us with a conundrum. Europe (and possibly the UK) is likely to go into a recession this year. Japan was already there before COVID-19 hit, so the virus can only make matters worse. China is emerging from its very deep slump; nobody knows exactly how badly its economy was hit. The numbers may well shock, but it’s clear that the Chinese authorities have the means to stimulate their country after activity returns back to normal. They, quite rightly, understand that throwing monetary or fiscal stimulus at a country that is in lockdown or quarantine will be money down the drain. They are therefore waiting for the resumption of business as usual before adding a potentially very large stimulus package to their economy.

The big question is how the US will fare. A lot will depend on how under-reported the cases are, given its poor testing record. If the panic seen in Europe is avoided in the US and the cases do not soar, President Trump may look like a hero for not casting the economy into a recession. The opposite scenario is quite scary: cases skyrocketing and the administration trying to shift blame onto others (possibly China, the Centre for Disease Control or even former President Obama). We can only imagine how markets would react to such a scenario.

We are not in a position to know which way the virus will go but can see that markets have already started incorporating a certain probability of the most extreme scenarios. It’s a question of how far markets will go.

What does the crude oil price fall mean?

The massive fall in crude prices is both negative and positive for the global economy. It damages capital spending by oil companies and can impact suppliers to their sector. It has beneficial effects for consumers and industrial energy users, nowhere more so than the US consumer, whose gasoline prices are directly related to crude costs. This is unlike European and UK consumers who pay large taxes and hence see less variable petrol prices. Nonetheless, the collapse in oil prices is feeding the equity bear market rhetoric.

Government vs corporate reactions

We are also quite concerned that, even if governments do not decide to shut down countries or regions, businesses may actually end up doing so themselves. When a company prevents travelling and large meetings, it does what is right for its employees, but if you multiply that action by thousands of firms, you get a total standstill in the economy. This is what we are starting to see in Europe, and the risk is that it may happen in the US, which is the driver of risk appetite in the world. If the US goes into a recession, markets have further to fall. If the US avoids recession, markets could rally quite sharply.

How we are responding

It is too early to say which way we could go and our views on markets will evolve based on the facts as well as the market reaction. It is clear to us, though, that trading in an environment of markets rising or falling 5% a day is unlikely to prove profitable and that calmer circumstances have to prevail to enable market participants to decide which positions to take. The lower markets go, the more likely there is value in taking a contrarian view and looking for risk assets as prices discount future scenarios. On the other hand, a sharp relief rally would lead us to think of rebalancing existing risk positions in our clients’ discretionary portfolios.

As we write this, trading on the US stock market has been halted to limit falls. This indicates a panic state that is unlikely to last very long.

The investments we like for our discretionary client portfolios have not changed since the onset of the virus. The ‘barbell’ of US and emerging market equities provides valuable sources of growth. We have, however, expressed misgivings about the European economy - and the reliance of European equities on cyclical export sectors - and we are glad that our positions there have been minimal.

In a nutshell, markets may rebound soon from their oversold condition, but we are not confident any rally will be durable until the full extent of the virus is visible outside of Asia, in particular in the US. We are highly encouraged by the situation in China, where 28 out of 31 provinces are now close to being back to normal, and that there is light at the end of the tunnel. We may not be quite there yet.

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The information contained herein is based on materials and sources that we believe to be reliable, however, Canaccord Genuity Wealth Management makes no representation or warranty, either expressed or implied, in relation to the accuracy, completeness or reliability of the information contained herein. All opinions and estimates included in this document are subject to change without notice and Canaccord Genuity Wealth Management is under no obligation to update the information contained herein.