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Holding It Together

It's been another wild week in financial markets, corresponding with the upside-down reality many of us are living through right now. We thought it would be useful to start by taking stock of where we are as of now. 

Since the market meltdown began on February 24, we've had 4 weeks of indiscriminate & forced selling across global stock markets followed by the last 3 weeks of rallying stock markets all over the world. 

To put some numbers around that, the S&P 500 was down c. 35% in the first 4 weeks, followed by a c. 25% rise off the lows in the subsequent 3 weeks, leaving it just c. 15% away from being back to pre-meltdown levels. Stock markets across the western world have broadly followed the same pattern, and these moves are definitely not normal. 

In the last week, we've seen the US stock market move c. 12% higher, while the UK's FTSE All Share and EUROSTOXX 50 both gained c. 9%. 

What's behind the rally?

It's down to a number of drivers, one of which seems to be slightly improved market psychology as mentioned last time. In addition to that, we've seen the following incremental improvements in newsflow, all of which in their own way help to reduce market volatility:

  • Central banks & government announcing new plans to help the economy on what seems like a daily basis
  • Oil prices stabilising following the price war between Saudi Arabia and Russia
  • Evidence mounting that Italy & Spain have moved beyond their respective COVID-19 outbreak peaks, reminding us all that eventually, we will stop living in this upside-down world and return to something that resembles normality

Monetary Policy: All in

The scale of the measures taken by the US Federal Reserve, the European Central Bank, the Bank of England and countless other central banks across the world in 2020 are reminiscent of the Global Financial Crisis a decade ago. 

We've already seen the US Fed slash interest rates to near-zero with Chairman Powell committing to keep them there for the foreseeable future. We've seen a similar move in the UK and quantitative easing measures announced across the board in the US, UK & Europe. But that's so 2008/09.

So in addition to all of this, we've seen the US Fed this week commit to lending to small and medium sized American businesses as well as local municipalities to the tune of $2.3 trillion. 

In the UK, we've also seen the Bank of England commit to lending directly to the British government, helping them bypass the need to issue debt to finance their crisis spending.

In Europe, the monetary policy response has been a little more muted, primarily because going into the crisis, the ECB had little room to manouvre (if you're a regular reader of this newsletter, you might be familiar with us shouting about this being a problem in a number of previous newsletters). But the Eurozone has, at long last, received it's much needed economic lifeline, which brings us onto governments...

Fiscal Policy: On the case

While the monetary policy actions so far are somewhat comparable to those taken in the Global Financial Crisis, the fiscal policy actions we've seen are truly unprecedented.

The European Union this week finally reached an agreement, delivering a rescue package for the economy which will amount to more than €500bn, comprised of up to €240bn in credit lines for member states which will be provided by the European Stability Mechanism - a scheme set up to deal with the Global Financial Crisis in 2008/09 and European sovereign debt crisis in 2011/12. There will also be an additional €200bn of lending provided by the European Investment Bank as well as a €100bn European Commission initiative supporting national short-time working schemes. This is obviously a meaningful rescue package, but the ECB has previously estimated the Eurozone economy will need up to €1.5 trillion of government spending. So while it's a start (albeit a slow one), questions remain as to whether this is really enough. 

Elsewhere over the past 3 weeks, we've also seen the US Congress deliver its own $2.2 trillion CARES Act, a package to cushion the blow for many Americans, as well as the UK Government having announced multiple schemes to support businesses, employees & the self-employed.

OPEC: Coming together

We won't spend too much time here going into the specifics on the oil dynamic that's been at play over the past couple of months - a quick google will give you plenty of material to read on the subject - but it's worth noting that OPEC has this week come back to the negotiating table and agreed a cut in supply of 10m barrels per day. While it's unlikely to be enough when you look at the demand picture - the global economy under normal circumstances has demand for c. 100m barrels of oil per day, with this number having dropped to c. 65m barrels in the COVID-era - it's a start, and the mere fact that the two largest OPEC producers have gone from bickering to constructive talks is reassuring, if nothing else.

Clearly, having monetary policy, fiscal policy and OPEC all pulling in a constructive direction helps - and this is in summary why we've seen markets bouncing so strongly off the lows seen 3 weeks ago. 

But all of this doesn't really make up for the loss in economic output that arises from the fact that swathes of the economy remain closed. Many people are out of jobs (we're seeing skyrocketing unemployment numbers across most major economies which are currently under lockdown) and many others, while not out of a job, are sitting idly at home.

So what's this rally all about, then?

In short, we think this looks a bit like a bear market rally. It's no secret that during global crises and strong bear markets like the one we're currently in, we often see stock markets rebound by almost as much as they initially fell. In this 2020 coronavirus bear market, we've seen major stock markets plunge 30-50% before climbing around 10-20% to leave us where we are today. 

Bear market rallies reflect the inherent uncertainty embedded in our reality. At the time, it's very difficult to predict exactly how the economic shock is likely to play out, and this gets reflected in overly pessimistic followed by overly optimistic outlooks on the future, driving huge sell-offs and rallies respectively. 

In the Global Financial Crisis, the biggest source of uncertainty was around whether we would have a complete collapse of the banking sector, and consequent collapse in the availability of credit (this eventually happened to some degree - you might remember the phrase "credit crunch" invoking all sorts of stress).

Today, the source of uncertainty is related to how long this drop in economic activity we're seeing will persist, and which companies will run out of cash / support before we can restore the global economy back to it's fully functioning glory. 

Will we be back to normal in 3 months? 6 months? 12 months? 18 months? Longer? The fact that this is so difficult to know for sure right now makes it difficult to know what the value of stocks, stock markets and financial assets in general should be. 

This is just one of a number of reasons for why we think it's wise to choose an investment strategy which will suit the levels of risk you are able and willing to take along with a long-term approach towards building your portfolio, as these levels could offer a good entry point into the stock market when you look back on it all in a few years' time. Check out our last two editions of this newsletter if you'd like to recap on this!

That's all for this week, so until next week we hope you're staying healthy and managing to stay happy wherever you might be!

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