Navigating Through This Market Mayhem
How do you predict the unpredictable? No one has any idea of how bad the current market scenario can get, or how soon will it bounce back. On a global and local level, we have dealt with several crises in the last 10-12 years. The 2008 global financial crisis, the 2013 taper tantrum, demonetisation in 2016, the IL&FS fallout, the North Korea military scare, and the trade war-related nervousness, all in 2018. To all of these events, there was a financial or political response that brought the markets out of choppy waters. Whether it was central banks injecting liquidity in 2008, the FCNR(B) swap in 2013, the government takeover of IL&FS and RBI's subsequent open market operations, or even Donald Trump's tweets about Kim Jong Un that dialed down the rhetoric, there was a policy response that soothed frayed nerves, helped market sentiment, and made people believe that they knew what is going to happen next.
How Long Will The Turmoil Last?
What do market participants do when they do not know what is going to happen next, as in the case of the current turmoil caused by the coronavirus outbreak, coming as it does atop an 11-year global bull market buoyed by truckloads of cheap money that has taken valuations to stratospheric levels? As Howard Marks says in his memo, 'no one knows'. Maybe a turnaround won't need too much, perhaps the mere passage of time with a month or quarter or two and gradual data improvement could do the trick. Governments may indeed be better prepared than earlier to deal with the coronavirus. If you ask any money manager or a market watcher about what will reverse the sentiment for the market, answers vary from the need of coordinated action, hoping for an early advent of the summer months, to accepting that its impossible to answer about the virus and its potency, because it is not a financial puzzle.
By now, the spread of the virus has caused massive upheavals in economies around the world. The number of cases in China may be coming off, but it is expanding at an alarming rate elsewhere. Italy, as of Tuesday morning, expanded the quarantine to the entire country as cases and deaths expanded. India has seen limited reportage of cases, but there is a fear of the disease expanding despite the coming summer, and fear can make people do things which the rational mind won't dream of. Companies have stated that while they are prepared for supply chain issues till the end of March, but beyond that is difficult to call.
It is this fear and risk aversion that is leading to yields dropping off the cliff around the world, as money moves into safe havens.
We have seen some serious tightening of credit markets, and conversations with global experts suggest that there is a possibility of a further crunch ahead. As much as we may want to put aside the impact of liquidity over fundamentals, liquidity reigns supreme in the short-run. Money rushing into safe assets can cause large dislocations in investment assets for a considerably long period.
Speaking of sentiment, Donald Trump is trying his bit. When markets sold off after he was seen as shrugging off the fundamental impact of the virus, he jumped right back by announcing that his administration will discuss a possible payroll tax cut with the U.S. Congress and that there will be “major” economic announcements Tuesday.
While the finer details are still awaited, this is what was missing the day the Federal Reserve cut rates - the intent to follow through with fiscal policy. It got the U.S. markets excited, with the Dow Jones Industrial Average rallying 1,167 points on Tuesday after a large crash on Monday. But, it's difficult to predict if it will last, S&P 500 futures are down over 2 percent.
Oil’s Free-Fall
The ‘new oil order’, as Goldman Sachs calls it, is doing its bit to add to the uncertainty, not just to sentiment but to business operations as well. It not only adds to the possibility of small and marginal global upstream players facing a viability crisis but also questions the near-term economics of the large shale gas industry in a first-world country like the United States.
‘The prognosis for the oil market is even more dire than in November 2014, when such a price war last started, as it comes to a head with the significant collapse in oil demand due to the coronavirus. This is the equivalent of a 1Q09 demand shock amid a 2Q15 OPEC production surge for a likely 1Q16 price outcome’, said a Goldman note to clients on Monday. While it is positive for India's macros, there are other believed second-order effects on a large heavyweight private oil and gas major, which has already and can further impact on the headline index.
Double-Edged Sword
India’s markets have not traded in such an environment for a long time. A sharp slowdown in domestic growth accompanied by an ongoing risk-off global money withdrawal, and possible recession scenarios in various economies. Yes, there are positives – lower crude, an actively-communicating Finance Ministry, a fast-responding RBI, and a belief that some earnings growth improvement is in store over the next year from the financial sector. However, that may not be enough to hold off FII outflows. As a result, every dip is being followed by further selling. Since it is difficult to time the market, there is no clear answer on whether to buy this dip or not. What great investors keep saying is, try and identify what looks cheap relative to fundamentals and stagger out purchases. This mayhem in the equity markets won’t last forever, but it may last for a bit longer than you or anyone else anticipates. As with every bounce, we need triggers. The key question is – are there any triggers in a non-financial distress situation like the present one, and do we even know them?
Niraj Shah is Markets Editor at BloombergQuint.