More a crisis of confidence than credit
Despite all the volatility associated with the spread of Covid-19 to more countries and more people, financial market liquidity has been holding up fairly well, though not without some challenges. The bigger issue for bond investors, and the public generally, is the fear of the unknown—how bad will the virus get, when will it end and when might it be safe to start thinking about buying risk assets (corporate credits and, for that matter, stocks) again?
Along those lines, we are monitoring three preconditions that would suggest potential stabilization and a bottoming in the risk markets: a peak in virus infection rates outside of China; extreme bearish investor sentiment; and renewed fiscal/monetary stimulus by countries and their central banks. Here’s where each stands:
- Virus infection rate outside of China: Still climbing. On Tuesday, the World Health Organization reported 4,105 new confirmed cases excluding China, where the infection rate has peaked, raising the total to 32,778. The number of countries/territories reporting cases also continues to grow, rising by 5 on Tuesday to 109. Today, the WHO officially declared the virus to be a global pandemic.
- Investor sentiment: Bearish but not extreme. According to various measures, this contrarian indicator is nearing levels that historically have represented good buying opportunities. The reason: when investors are their most pessimistic, opportunities for future gains tend to improve as extreme pessimism tends to precede market reversals.
- Fiscal-monetary stimulus: A handful of central banks and governments have taken steps to prop up their economies amid this epidemic, the latest coming this morning when the Bank of England made an unscheduled 50 basis-point cut in its benchmark rate to a record low, reintroduced a low-rate loan program for small and midsize businesses and eased bank capital requirements. At next week’s March meeting, the Fed might cut its funds rate by another half point, on top of last week’s surprise inter-meeting 50 basis-point cut. Congress and the White House, meanwhile, are discussing but have yet to act on various stimulus measures, including a possible payroll tax holiday and aid to small businesses and workers.
It’s never easy when the risk markets are in a sharp downward cycle—the past few weeks have seen the biggest decline in global equities since the 2008 financial crisis and the flight to safety drop Treasury yields across the curve to record lows. The market appears to be pricing itself for a high probability of a recession that, if it does come, is more likely to be shallow than deep. But if history has taught us anything, it’s that the economy eventually will improve and the appetite for risk will return. We won’t pretend to know when that happens, but we do believe that three markers above should serve as guideposts as the unknowns become known, helping fear give way to confidence.