Financial markets may bounce back faster than the economy. Signs of a V-shaped upswing abound, although investors are facing unprecedented volatility. At the same time, economists predict bleaker days for the economy.
The first quarter was the most volatile since the financial crisis of 2008, says Albert Ngo, senior portfolio manager, Empire Life Investments. Although the magnitude of the current sell-off was smaller than in the last crisis, its pace was nearly twice as fast, Ngo notes in a blog published on April 14, 2020.
“In a matter of a couple of weeks, we saw corporate bond spreads go from historic lows to cyclical highs. It was the type of market where there was really nowhere to hide other than government bonds, which did their job of acting as insurance,” he explains. “Investment-grade corporate bonds were down 3%; high-yield bonds were down 13%; Canadian preferreds were down 25%, and equities were down around 35% with the heaviest losses occurring within a two-week time frame,” he wrote.
Ngo does not see a return to 2008. “We are not questioning the solvency or the functioning of the financial system. Instead, in Q1 we had two big external shocks due to the COVID-19 pandemic and the oil price war between Russia and Saudi Arabia,” he added.
Sell-off exacerbated
Ngo explains that the speed and magnitude of the sell-off was exacerbated by two factors: 1) the growth of fast money such as ETFs and algorithmic trading in credit markets and; 2) the temporary lack of liquidity as many participants rushed in to raise cash at the same time.
Clément Gignac, Senior Vice-President and Chief Economist of iA Financial Group, says the bear market deployed very quickly, with the fastest plunge in history. Global markets lost 30% in just a few sessions. In a webinar organized by CFA Québec, presented on April 22, 2020, he nonetheless predicted a V-shaped trend for financial markets.
Sustained recovery
He observed that assets such as long-term government bonds and gold are prospering. “People were surprised when I forecast a V-shaped recovery in mid-March, but for the last few weeks the indexes have already regained nearly half of what they lost. I don’t expect that everything will be back to normal in three months, but the speed of the recovery may surprise people.” As one example, Gignac cites the MSCI World Index, which rocketed to the fastest recovery in stock market history, according to Goldman Sachs Investment Research.
This recovery is sustainable, he believes, adding that Wall Street is well-positioned for the post-COVID-19 era because the US market is highly concentrated in information technologies (25.5%) and healthcare (15.4%). Gignac thinks the crisis is spurring innovation in the technology sector. Asset management will become crucial in the post-pandemic economy, he adds.
Albert Ngo sees opportunities emerging. “As spreads went from historical lows to cyclical highs, we are seeing many attractive entry points to invest in good businesses with strong management teams and balance sheets at valuations we haven't seen since the financial crisis. These types of opportunities don't come along all the time,” he says.
Economic comeback slower
The economy will take longer to recover than the financial markets, Clément Gignac cautions. As the number of COVID-19 cases begins to taper off, prompting the gradual reopening of some economies in Asia and Europe, collapses caused by confinement cannot be ignored.
The world is witnessing an economic meltdown compounded by a steep plunge in oil prices: global demand for black gold plummeted by 20% to 25%. Canada alone lost one million jobs. Gignac anticipates a U-shaped rather than V-shaped economic recovery as sectors such as restaurants and tourism remain closed for longer in a gradual resumption. In his most optimistic scenario, Gignac expects the economy to return to its pre-crisis level within the next 15 to 18 months.
“This contraction is substantial but will be temporary,” Gignac says. “Budget deficits will also be temporary because these budgets ensue from the exceptional measures taken by governments.” He mentions that Canada is one of the G20 countries whose government has intervened the most to support the economy: the stimulus to date amounts to 10% of the value of the GDP, versus an average of 7.5% for the G20 as a whole.
Contrary to traditional recessions, the economic contraction during the COVID-19 pandemic was dictated by the authorities, he adds. “We are seeing the deliberate closure of the economy, which is completely different from the previous cycles,” Gignac says, adding that the tax and monetary authorities of the G20 countries have pledged to do everything in their power to combat the coronavirus and prevent a recession like that of the ‘30s.
Permanent damage…
A survey conducted from April 9-17 by the Association des économistes Québécois, in cooperation with Raymond Chabot Grant Thornton, found signs of fear that the pandemic is jeopardizing companies’ survival. 68.9% of the respondents see a risk of major and permanent damage if nonessential economic activities do not resume in the next two or three months. The permanent closure of businesses was singled out as a possibility.
“The stoppage was decreed by the Québec government over one month ago, but we noted that 21% of respondents already view the damage as significant and think it will affect the economy permanently,” the association says.
The survey also found that the pandemic will amplify debt considerably, which will stunt economic growth. Higher government debt can affect the provision of services or the burden on taxpayers, the survey adds. “A slowdown in trade globalization can also be a notable consequence of the pandemic,” the association mentions.
Added value of advisors
In these times of volatility and economic uncertainty, clients are keen to communicate with advisors about their investment, says Ian Kerr, Senior Business Development Manager with BMO, in a webinar IDC World Insurance Network produced for its advisors.
“They understand the ups and downs of the market, but you need to talk to your clients about some of the qualitative aspects. Why did they buy the segregated funds in the first place. Sometimes, it may not be the rates of return. It may simply be a conversation around some of the attributes. Sometimes, they just want reassurance,” Kerr explains.
He urged advisors to communicate with their clients, especially during this lockdown. The current market is creating an excellent opportunity for advisors to review their clients’ assets. This is the ideal time for advisors to offer to review all the clients’ assets, not just those that are under their administration today, he underlined.
