With the VIX chart of Wall Street tracing the sphygmometer readings of a Hypertension patient, this article is pumped in with medical analogies to convey the general market phenomena and bring home the idea that “Any Economy is as strong as its Health System”.
The year 2020 was dreaded for long, not just because the twenties in every century have handicapped economic machinery but also because many economists had foreseen that the 3Ds of Debt, Disinflation, and demographic inequality has the potential to bring down the world on its knees. They all thought of dealing with this exacerbation by somehow delaying it, but the 4th D of Disease made the door of ICU seem even closer.
In earlier articles of this series, we have discussed the way consumers and producers have dealt and plan to deal with the pandemic. No matter who you are, there always lies an investor inside you trying to make the best out of savings. With the stock markets hitting its lows and shares losing all the value that they had earned over past decades, people are playing safe by getting away with minimum losses. But that can’t be the strategy for every instrument because what cured Malaria, can’t cure pox. No doubt that short term results depend on the trajectory of disease making forecasting difficult and we know that Investment is nothing but a function of future expectation. So let’s examine what each market is pricing for as per experts:-
Equity Market: The one with higher returns and higher risk has become the cradle of big losers. Investors on a share shorting spree have not spared even the ones with the strongest balance sheets. This moment of uncertainty outside the ER calls for checking the medical history of the patient before betting on its death. Few companies which were not trading at over-inflated prices have to be identified. The glimmers of optimism are those firms that either have lower debts or have retained their brand image by sticking to ethical trade or heading towards leading the fourth industrial revolution with AI and IT. While export-oriented firms face a period of gloom for at least coming 4-5 months. Before investing, the fundamentals that one should look for are gross and operating margins, return on equity, return on invested capital, the strength of cash generation measured by free cash flow, return on capital invested with critical analysis of the volatility of earnings growth.
Bond market: On 12th March, Fed announced Quantitative Easing of $1.5 trillion which is nothing but the expansion of balance sheet by buying long term securities from commercial banks and crediting their account in the fed balance sheet. As soon as this is done commercial banks exceed their reserve requirement and can encash the liquidity. The transmission plays an important role, it becomes necessary for this credit to be lent out for investment otherwise the motive of bringing down the interest rates would fail. Shockingly, just the day this was announced yield on US 10 year bonds rose, indicating bondholders were dumping US treasury amid equity bloodbath. May be it is not just the fear of recession but also the need for funds and liquidity in hand. On Sunday, came more emergency measures trying to revive an economy put on a ventilator receiving external stimulus in the form of coordinated monetary and fiscal policy, interest rates were cut to zero bound. But the panicked market has remained unimpressed because clearly it fails to understand that disinvesting from fixed incomes securities and keeping in savings is not the smartest move because Inflation like the drug Orlistat won’t allow the receiver get any fatter. What’s even more worrisome is looming corporate debt crisis which can be as high as $12 trillion globally because many leveraged companies with production put on halt will default and the government will have to bail out or nationalize these firms. This will further put the exchequer under pressure.
Foreign Exchange and Gold: As we talk about more domestic currency buying less due to Hyperinflation and monetary easing announced by central banks, the US Dollar is bound to get stronger. Adding to the plight, investors are disinvesting from dollar-denominated bonds in emerging markets. To retain investments and prevent CAD from swelling up, countries need to raise interest rates that contradicts demands of the domestic economy. Amid a worldwide dollar shortage, Yen has remained stronger because it is one of the least affected countries by corona due to its vigilance and hygiene. Investors are looking for less volatile economies and therefore Chinese are trying hard to show symptoms of recovery, get an early discharge and be investors’ haven. In fact, the Chinese government has started owning shares in loss-making companies because smarty buys when bears are selling! Gold is supposed to re-emerge amid the crisis but it’s price hasn’t peaked substantially because if the chances of this pandemic extending for years increase then Gold prices would further fall down and buying now will be a bad idea in terms of locking up liquidity too.
Commodity and Oil: Facing demand and supply shock at the same time, their prices have dropped, shippers are diverting their cargoes elsewhere with the world standing still and empty ships lining up at Qatar, the largest supplier of liquified Natural gas. Oil barrels have been priced at its lowest by OPEC alliance led by Saudi Arabia to keep their economic machinery greased. China being the largest importer of oil has contributed majorly in demand dip. Copper smelters have shut down their productions and in absence of drivers loaded trucks stand parked at the stations making losses post-pandemic inevitable. But this slump is expected to be short-termed, with most economists relying on Pent-up demand for faster recovery. However, the forex rate will continue to play an important role in the demand recovery aided by Petrodollars and Petroyuan. This is how the major investment markets have perceived economics so far.
While people are together in this War against a fatal virus one should not forget that during war production houses work day and night, more people get employed (maybe at lower wages leading to disinflation), demand is at all-time high and it is the phase of ultra productivity while the destruction from external sources continues. Few economists expect this world crisis to be the worst in human existence. They say that important economic relations are failing with interest rates becoming less of a function of monetary policy, gold prices and QE’s relation becoming less negatively correlated, AI and IT taking up jobs and the burden of sovereign debt piling up, we have filled the space with bubbles without an exit plan. But there will always be a ‘maybe’.
Maybe things won’t end that badly, maybe a wave of global integration will spur similar to one that emerged in the post World War II period with health becoming global public good. The objectives that even the debates on climate change were not able to achieve might seem a necessity now even by the most self-centered capitalist societies.