The strong and unsettling impact of global disruption on financial markets is nothing new. Environmental catastrophes, wars, and pandemics can compromise public safety, mental and physical health, infrastructure, international relations etc. Subsequently, these drastic changes also seem to affect businesses and the global economy in a big way and fuel substantial ambiguity and signify a significant threat to the investment landscape. As well as the people, and the financial markets that execute those transactions.
The Covid-19 pandemic fits well into this global disruption profile, damaging economies and threatening stock markets around the world. The stock market plummeted more than thirty percent and erased most of the gains achieved over the past few years. Since the peak of the Covid-19 outbreak has not been experienced. And it is unclear what the future holds for all things COVID-19.
But, even though the financial markets might have experienced a bit of a roller coaster ride at the start of the pandemic, they have been posting some record gains. Some insights of note include but are not limited to:
- There are more first-time investors now. Despite market volatility, the pandemic has prompted a rise in first-time investors. These new traders, many of them young adults, hadn’t participated in the stock market before the pandemic due to high prices. The initial lows created by the COVID-19 pandemic created the perfect storm for new investors allowing them to participate in the markets; COVID-19 has made stock trading accessible.
- Tech stocks have skyrocketed. As organizations and governments adopted work-from-home models and young people attended virtual school, technology-based stocks surged, achieving unprecedented success levels. Technology has filled the gap providing a way for people to communicate, connect, work, shop, eat and entertain themselves from their homes. As a result, when people found leaving their house to be too risky, tech adoption soared. And this trend could continue well past the pandemic.
- Commodities experienced some tumultuous market performance throughout the pandemic. Commodity ETFs dipped drastically during the early part of the COVID-19 pandemic, with a few recovering just as radically. While commodities have traditionally been a refuge from market volatility, they’ve proven slightly as unstable as anything else amid the pandemic.
- Health stocks fell dramatically in the pandemic’s early days despite an increased need for hospitals; the medicine business declined as facilities had to conserve resources for more dire procedures. As various vaccines hit the market, health stocks have started to see a recovery. With the accumulation of patients needing elective procedures, a substantial rise could be on the horizon. When the pandemic abates, healthcare and related health stakeholders could see significant returns.
Though it’s too early and to know just how long the pandemic will last and what will happen economically. Future lockdown measures, distancing orders, and stimulus packages could cause additional stock market volatility; the uncertainty will continue for some time. Whatever happens, the stock market is not immune to the effects of the pandemic. As the pandemic continues, more changes and continued unpredictability could arise.
So as the markets race higher that is in stark contrast to the economy which continues to grow at a snail’s pace. But, it is important to consider the fact that the market is not the economy.
The role of government
Today government officials face a unique challenge in figuring out how to weigh people’s lives against the impending recession created by physical distancing, lockdowns, and rolling closures. Without robust data on the death rate and the virus behaviour, most world leaders must plan with the worst-case scenario in mind. This thought process helps to explain the escalating pressure on government officials to implement lockdowns. Once the spread is under control, and there are better estimates, governments’ next step will ensure that their regulations are backed-up by new data.
Our economy is receiving an extreme adverse shock. There has already been a significant increase in demand for assistance in the form of credit divergence. Companies that were viable until recently now seek financing to survive the current crisis. Government finance programs facilitating credit and loans are essential, particularly for small and independent businesses. The idea being that such intervention will help these businesses regain profitability once the world has recovered.
In many countries, firms have become highly indebted and are now vulnerable to rapidly deteriorating economic and market conditions. Amidst an extended accommodation monetary policy period, the meagre cost of borrowing has allowed for unprecedented corporate debt issuance. Consequently, the corporate debt is at extremely high levels throughout many of the Group of 20 nations. The growth of leveraged loans outstanding within the US has counteracted a slowdown in lending from financial institutions, providing indebted corporations with capital. Many corporations used this debt to pay dividends and buy back stock, increasing leverage making them more vulnerable to sudden declines in operating revenues. Also, lower-rated credit issued in bonds, non-investment grade bonds, and leveraged loans has risen to lofty levels. Additionally, loans assessed in collateralized loan obligations have been distributed throughout the financial system to many investors, including institutional insurers, pension funds, REITs and retail investment funds.
Market risk aversion
The market enters 2021 following encouraging trends:
- Vaccines will impede the spread of the Covid-19 virus.
- S&P 500 earnings are anticipated to continue to recover.
- The Federal Reserve has assured investors that it won’t raise interest rates.
- Fiscal stimulus will continue to flow into the economy.
But the stock market, always looking forward, seems to have priced in a more robust economy and a diminished coronavirus pandemic; this raises the threat that any disappointment in the recovery will rattle investors.
The Nasdaq made significant gains for the second year in a row. It is possible that the Nasdaq can register a third year of double-digit returns given its broad exposure to tech, highly leveraging innovation.