The outlook is always uncertain. That is a fact of life for investors. Markets are in constant motion, revising views and valuations as new information arrives. However, our investment horizon demands that we have a view on where things are going and we need to test that view against current asset prices.
The coronavirus outbreak is no different: we need to decide whether we think current prices fit the facts.
Here are the key signposts that we think investors should monitor to assess the outlook.
1) The virus and the vaccine
News on the successful re-purposing of existing antivirals to treat the disease and ultimately progress in the development of a vaccine are the most important markers of all. There is obviously a risk of false positives, but significant news from credible sources would materially lift market sentiment.
2) The public health response
The key consideration driving the public health response right around the developed world is to prevent the flow of new cases overwhelming the capacity of the primary healthcare system.
To determine the number of people who have already been infected and (hopefully) now have an immunity, a serological test is a potential game-changer because it will allow the authorities to estimate when herd immunity will be reached and when shutdowns are no longer necessary. The arrival of that test and data on rates of acquired immunity will be key news for the market.
3) Economic cost of social distancing
It is difficult to know precisely the impact on economic activity of the lockdowns. Reports suggest unpublished ECB estimates of the negative impact on economic activity in the eurozone range between 2% and 10%; a three-month lock-down could have a 5% hit on growth.
The more severe the lockdown and the longer it lasts, the larger the effect. Equally, once the measures lapse, employment should return to close to normal. The level of output and employment will be far from trend during the shutdowns and much closer to trend otherwise. The pace of economic growth will be more volatile.
4) Economic policy response
Early on in this crisis, it became painfully clear that monetary easing was not enough to deal with the threat of a virus. Markets were forced to confront awkward questions: what would constitute enough? By whom? Would it be delivered in time? The evolution of economic policy will be a key signpost.
The cumulative monetary and fiscal stimulus is building. Central banks are making full use of the policy tools to maintain liquidity in core wholesale markets and prevent them seizing up.
Finance ministers have followed the overarching principle of “whatever the cost… socialise all losses”. That can include credit guarantees and loans to companies to keep them in business. Or even making direct payments to all households.
We are struck that truly radical ideas – cash payments to all households, monetary financing of deficits by central banks, or central banks acting as a risk taker of last resort, buying risk assets to restore calm to febrile markets – are now being seriously discussed in policy circles.
5) Animal spirits
There is a concern in our mind that the economy could become stuck in a rut of low, or even no, growth after the shock of the social distancing measures. That scenario would not be supportive of a rally back in risk assets.
Measures of consumer and business confidence – or for want of a better phrase ‘animal spirits’ – are a key signpost. Where the corporate sector is concerned, employment and investment intentions could also contain useful information.
6) Aligning expectations
Our final signpost is when and whether the market fully embraces the near-term social and economic consequences of the virus. Multiple shutdowns may be necessary to contain the virus in the short run. That would imply a much larger cumulative economic cost. As reality dawns, prices may drop further.
One way to ascertain whether the market has come to terms with the strategy that the authorities are pursuing is when prices are no longer sensitive to news about the public policy response. Another way to assess investor expectations is to keep track of the research and commentary that is published by investment professionals and to monitor whether views are converging on reality.
Summary
These are the signposts that we believe investors can use to monitor the outlook, which will in turn influence the trajectory of markets in coming weeks.
Waiting for incontrovertible evidence of the end game means prices will have already adjusted, either rallying back to ‘peacetime’ levels or selling off. It is essential to be ahead of such developments.
Over the coming weeks, we will provide a weekly update on how these themes are progressing and the implications for investors. Please visit Investors’ Corner on Wednesday for more information.
