- Numbers of new cases and deaths seem to be declining in the current hotspots, namely Italy, Spain, and New York
- Personal Protective Equipment and new tests seem to be coming on line with rapidity.
- At least 70 contenders seem to be barreling forward to develop a vaccine.
- Big Tech seems to be mobilizing in the fight against the virus, and despite privacy concerns, may help identify and trace cases.
Financial markets seem to have recovered roughly two thirds of the precipitous 30%+ drop in the days around March 23rd.
I am surprised at the number of investors with whom I speak, or whose opinions are expressed in the media, who seem to be optimistic that this will be a short-lived “V-shaped” recovery, most seemed swayed by the aforementioned developments. In my last blog, I expressed the opinion that the potential bad news is not priced into markets. Two weeks later, despite further rises in financial markets, I am even more convinced that there is way more short-term downside than upside. (It reminds me of the joke: what is an optimist?—A poorly informed pessimist). So forgive me if I proceed to provide a fairly lengthy summary of things that could go wrong in the short- to medium-term. The likelihood of any individual item on the list occurring might be low, but the likelihood of at least several of them happening is quite high:
- During my 35 years of working in financial markets, I have yet to see such a divergence between Wall Street and Main Street. In the US alone, close to 10% of the work force applied for unemployment insurance, in the past three weeks alone. 1 Many countries are forecasting GDP declines of 20-30% for Q2 2020 compared to Q2 2019.
- Waves of bankruptcies are likely to hit, government stimulus being insufficient or too late to stem the tide. Hotels, restaurants, airlines, cruise lines, automotive industries are some of the obvious sectors, but there are many others.
- China and other countries are fighting a possible resurgence of Covid-19. New hotspots are sure to emerge. This and the previous two points are likely to cause sustained “demand side” shock to the world economy.
- As the world goes through de-globalization, supply chains may break down. At the very least input costs may be expected to go up and productivity come down, further contributing to a supply side shock.
- Company earnings announcements will provide a steady diet of negative news in the coming months, as losers to coronavirus outnumber winners by a wide margin.
- Over $100 billion of portfolio capital has been withdrawn from emerging markets over the past two months. Over 90 countries have applied to the IMF for assistance. The pandemic has not even begun to run its course in emerging markets (e.g. India, sub-Saharan Africa, etc.), where population density is high, sanitation poor, resources low.
- The oil and gas sector will remain in deep crisis, despite the recent agreement between Saudi Arabia and Russia. Even despite that OPEC+ deal to cut production has been reached. Given the high level of indebtedness in the sector, a wave of energy sector bankruptcies is expected in the coming quarter.
- Bankruptcies across numerous sectors could lead to a banking crisis in one or more countries. Global corporate and consumer indebtedness is much higher today than it was in 2008, not just in absolute terms, but also relative to GDP. The need for detailed disclosure of derivatives was unfortunately not a lesson learned from the 2008 economic crisis. Despite many banks being better capitalized than in 2008, the parallel supply and demand side shocks may also prove larger. Ultimately, it will boil down to confidence in the banking sector.
- The possibility of sovereign bankruptcies cannot be discounted either.
- The lack of solidarity of the northern European countries behind the Covid-19 outbreak has recently brought impassioned pleas from the prime ministers of Spain and Italy, bringing into question the very survival of the European Union. The eur 500 billion solidarity fund announced by the European Union 2 may well prove too little too late.
- Iran is moving missiles to provide greater coverage of the Straits of Hormuz. China has mobilized an aircraft carrier in the Pacific, while the two US aircraft carriers in the area are at port, due to Covid-19. Might there be a regional war or land grab, taking advantage of the weakness of the US in lockdown?
While in the short-term, increases in unemployment and bankruptcies, along with massive declines in energy prices will lead to strong deflationary pressures, in the longer term massive global monetary and fiscal stimulus may lead to even more massive inflationary pressures.
Lockdowns should not be viewed as an end, but as a way to bring down the number of cases to a level where cases may be tested, traced and isolated. Unfortunately, available testing is still woefully inadequate in most countries—so we are paying the high economic price of lockdown, without deriving the benefit, contributing to new hotspots emerging And then there is always the possibility of a dangerous viral mutation.
My message is not to sell, let alone sell everything. As the saying goes, “buy when there is blood on the streets, even if it is your own”. So prudent buying for knowledgeable investors is probably justified. But exercise extreme caution in identifying opportunities. Are they really opportunities, or are you catching a falling knife? “Average in” over at least several months of purchasing, and hedge your bets (e.g. with gold). But remember, there is still more risk on the downside than upside.
Information, data, and analysis in this article shall not serve as advice to any investment decision. Neither Euro-Phoenix Ltd nor any of its officers and directors make any representations or warranties, express or implied, as to the validity and/or accuracy and/or completeness of the information set forth in this article.