“Make this stop.” The headline on Bank of America’s rejig of its economic forecasts for Europe summed up the mood in financial markets.
City analysts and investors have lost their bearings. How do you make sensible estimates about the financial fallout from a virus with the potential, as in parts of China, to bring economic activity to a standstill?
Spreadsheets that plot the interplay of interest rates, government spending and corporate earnings are unreliable when the main risks are unknowable. How far will infection spread, and for how long, and how effective will prevention policies be? And, just as importantly for calculating economic impacts, how much damage would draconian containment measures do? Closed schools and factories and travel bans have heavy short-term economic costs.
For what it’s worth, Bank of American’s pundits now reckon global economic growth will slip from 3.1% to 2.8% in 2020, but that counts as cheerful versus some predictions. Others are already predicting outright global recession, which almost nobody was forecasting just a week ago.
In the circumstances, it’s hard to describe this week’s stock market plunges as irrational. Comfortable assumptions have been overthrown suddenly. The S&P 500, the main US index, hit an all-time high only 10 days ago, with most investors seemingly happy to believe the coronavirus crisis would be a China-only affair that would be overcome quickly.
Once that complacent view was shattered, violent stock market moves were almost inevitable.
Look at British Airways-owner IAG as a small example. “Given the ongoing uncertainty on the potential impact and duration of Covid-19, it is not possible to give accurate profit guidance for 2020 at this stage,” the airline said on Friday, stating the obvious.
So what’s a fair price for its shares? They’ve fallen 25% in a week but almost any level can sound vaguely reasonable because the range of possible outcomes is suddenly vast. The worst disruption could pass within a month; alternatively, the entire airline industry could face a summer wash-out followed by years of upheaval if, as some suggest, the coronavirus ushers in a new era of de-globalisation in which companies shorten their supply chains.
In aggregate, this week’s stock market falls have been staggering. The approximate 10% fall in the MSCI All Country World Index – a proxy for all the world’s stock markets – equates to the evaporation of more than $5tn (£3.86tn) of stock market value.
The FTSE 100 index, London’s blue-chip index, has fallen 11% in a fashion that recalls 2008 after the collapse of US investment bank Lehman Brothers. As then, markets were initially slow to react to a major global event but then sold off steadily. The FTSE 100 fell only 3.9% on the day after Lehman’s failure but then plunged 27% in stages over six weeks.
In stock market terms, there are two key differences from 2008 – and neither is encouraging if you believe the coronavirus has the potential to spread fear for a long time yet.
First, as the S&P 500’s recent all-time high illustrates, this shake-out has started from elevated levels. Back in September 2008, when Lehman fell over, the credit squeeze had begun and stock markets were already about 20% off their peaks. This time, the change of direction has been screeching: the S&P’s move into “correction” territory, regarded as a 10% fall from a recent high, happened over six trading days – a record.
Second, back in 2008, central banks and governments rode to the rescue with a package of measures to save the global banking system and reignite growth. In the current era of trade wars and geopolitical tension, international cooperation feels far less likely to happen.
In any case, purely financial measures look the wrong tool for fighting the fallout from a healthcare crisis.
Bond markets already expect a cut in US interest rates, but rates are already below 1% in much of the western world, including in the UK and eurozone. And cheaper money doesn’t help an otherwise strong UK manufacturer that only needs a bespoke component that is stuck in a closed Italian factory.
Mohamed El-Erian, chief economic adviser at German insurer Allianz, put the point this way: “Central banks can counter financial dislocations but are unable to restart economic activity as they don’t reach the underlying disruption.”
Financial remedies might, of course, be more helpful once recovery has started after any coronavirus-created downturn. Credit guarantees, buying corporate bonds, ordering banks to be forgiving on loans – in other words, post-2008 policies – could accelerate the bounce-back.
But one has to hope that stage is never reached: it would imply a lot of economic damage beforehand.