Recovering markets may offer a few signals about what lies ahead.
There's an early moment in most horror films, just after the cataclysmic storm or earthquake, when the sun rises and life appears to return to normal. Then the main characters notice things that seem a little off: a strange sound emanates from the cellar, they can’t see themselves in the mirror or frogs may start gathering in the backyard.
Investors have been grappling with similar signs even as markets stabilize from the initial shock of the Great Lockdown: bid-ask spreads still out of whack, oil contracts turning negative, bonds behaving like stocks.
For the global economy, the terrors ahead still depend overwhelmingly on how fast doctors, scientists and governments develop strategies to test, track and treat COVID-19. The jaw-dropping macroeconomic data will lag too much to provide any real clarity, but weird anomalies aside, investors can still look to markets themselves for the best guide to the path ahead.
First, sovereign bond yields suggest that the economic damage is real and the recovery will be slow. Muted expectations, limited risk appetites and massive central bank intervention have moved us from a “low growth, low return” world to an “even lower growth, even lower return” one.
If bond prices have been bid up by central banks, commodity markets confirm that demand has collapsed and will not snap right back. Beyond oil markets distorted by political rivalry and limited infrastructure, the prices of steel, nickel, corn and sugar all reflect the weakness. The copper price, in terms of the rising price of safe-haven gold, is especially striking.
Source: Factset. As of April 23, 2020.
Second, stocks, as usual, are much more optimistic that the recovery will come, even if it may be delayed. Some of this is surely helped by central bank programs to purchase corporate debt. Some may be a market getting ahead of itself. But part of the discrepancy could be that investors are already looking past this year’s blow to next year’s vaccine, when more normal activity is easier to picture.
Simply looking at market action since the beginning of the year, Chinese stocks have performed best, with the United States in second place and Europe and Japan lagging. In the last month, U.S. stocks have snapped back more than Chinese, but they are both still ahead of Europe and Japan. This more or less confirms the IMF's outlook for the recovery: China is the only major economy recording both positive growth this year and a large bounce next year. Among developed markets, the United States falls less and recovers faster than Europe and Japan.
GLOBAL MARKETS YTD
(INDEXED TO 100)
Source: Bloomberg. As of April 24, 2020.
The third market message is that when the rising tide comes, it will not lift all boats. Just as the disease is striking different economies at different times, the recovery will be segregated by varying policies about how to resume activity and contrasts in renewed outbreaks.
This may be reflected in global currency markets that show a return to more normal patterns. Over three months everything sold off against the dollar, but the last month has provided much greater differentiation.
EMERGING MARKETS CURRENCY PER USD
(DAILY % CHANGES, March 23, 2020–Present )
Source: Bloomberg. As of April 24, 2020.
Harder to see beyond these early trends is just how the global economy will change on the other side. Markets were already grappling with fundamental dislocations from domestic politics, technological innovation and global relationships. Now there will be more questions about consumer behavior, risk appetite and economic interactions.
Will the shock to corporate and household balance sheets linger? Will commercial real estate and business travel ever fully recover after a mostly successful experiment in working from home? Still more important will be how much large increases in government debt crowd out the private sector or whether these new vast new financial assets are just tinder for renewed inflation.
"Almost as devastating as the crisis shock itself has been the disorienting sense that past correlations no longer work. It’s hard to rely on models that depend on a reversion to the mean when the mean itself is on the move."
What is particularly difficult for an investor is that the tools of the trade depend on traditional patterns offering a guide to the future. Almost as devastating as the crisis shock itself has been the disorienting sense that past correlations no longer work. It’s hard to rely on models that depend on a reversion to the mean when the mean itself is on the move.
Movie heroes usually emerge from their battles with demons and monsters triumphant, but somehow changed. Investors will come out of this crisis with a fresh reminder how shocks can be devastating and markets can turn surreal. Over time, most patterns will likely return closer to normal, but the savvy investor will keep a sharp eye out for any unusual clustering of frogs.