Lockdowns and border closings have accelerated in the past week across much of the world, and equity markets have continued to tumble as financial market uncertainty soars. We have noticed how a number of questions keep recurring when customers contact their investment advisors at Danske Bank at the moment. Below, chief strategist Henrik Drusebjerg and his strategy team respond to the most popular questions:
What do you recommend that investors do right now?
Despite the very considerable uncertainty, we generally recommend that investors hold onto their investments if they suit the investor’s investment profile. Common to all historical crises is that equity markets have always bounced strongly back again, and we expect that to happen this time too. As long-term investors, our best protection against loss has always been time and patience.
When do you estimate equity markets will bottom out – and which indicators are you monitoring to assess if we are approaching that point?
Whether equities bottom out tomorrow, in a week or in a month is impossible to say – and strictly speaking you are only aware of the low point some weeks after you have hit it. However, even if the time ahead is a long, hard struggle for the global economy and the financial markets, we expect we have put the worst behind us in terms of equity markets.
There are several indicators we monitor:
- VIRUS SPREAD: We are focused on the further spread of the coronavirus, and here we would like to see the comprehensive measures taken to slow the spread bearing fruit in the coming weeks. China, fortunately, still appears to have the virus under control.
- GOVERNMENTS AND CENTRAL BANKS: Furthermore, we are closely tracking the many economic and financial measures governments and central banks around the world are enacting. These measures play a decisive role in averting an extended economic crisis, and we generally assess that governments and central banks are currently taking the right – and necessary – steps to support economies. Most recently, the European Central Bank has announced a massive bond purchase programme (so-called quantitative easing or QE) for up to EUR 110bn a month to buy government and corporate bonds, so yields and interest rates do not explode in, for example, Italy. This is a huge sum and could prove vital to turning the situation around and avoiding a major economic meltdown in Europe.
- PSYCHOLOGY: Finally, market psychology will play a key role in causing the extremely negative sentiment prevailing right now to turn. This morning (Thursday 19 March), global equity markets were down roughly 30% from their peaks. At some point so much negativity on future expectations will be priced into equity prices that there will be a much greater likelihood of an upside surprise.
Experience tells us that the turnaround in equity markets comes some way ahead of the turnaround in the economy once investors begin to glimpse the first bright spots on the horizon.
Are we now in an economic recession – and if so, how long will we be here?
Yes, the mammoth slowdown in economic activity around much of the world in recent weeks means we are now in an economic recession, and we will undoubtedly remain here in the coming months. At Danske Bank, however, our main scenario remains that the economic recession will not be long-lasting – in part because governments and central banks, as mentioned, are launching extensive economic assistance packages to support companies and save jobs. We therefore expect that the negative effects of the coronavirus on the economy will be temporary, and that economic growth will move into recovery mode in the second half of 2020.
Hence, we also expect this will be more of a so-called technical recession, which is a couple of quarters in a row with negative economic growth, rather than a recession in the more classical sense with a long-lasting slump in activity.
How long do you expect it will take for equity prices to return to pre-corona crisis levels?
Giving a specific answer to this question is impossible, as it depends, for example, on further developments in the coronavirus in the coming weeks and months as well as how quickly and entrenched the subsequent recovery is.
We are now in a bear market, which is the term for a period characterised by price falls of at least 20%. Historically, the US equity market (S&P 500 index) has experienced 13 bear markets since 1928, with prices falling by an average of 39%. On average, equities have taken around 4 years and 4 months to recover to pre-bear market peaks. However, historical data are not a reliable indicator for the future. Every single crisis has its own characteristics and its own course of events.
Whereas some bear markets have been triggered by long-lasting economic recessions, we expect to see a relatively speedy recovery in economic growth following the corona crisis. Naturally, that would be a very positive thing – also for investors.
Should I use these pronounced price falls to buy into equities?
The level of uncertainty is currently too high for us at Danske Bank to increase the share of equities in our portfolios. Should you wish to capitalise on recent price falls to buy equities, we generally recommend that you diversify your investments rather than invest in individual stocks – for example, via an index-linked fund that invests in a broad selection of equities. This will reduce your risk of having excessive investments in companies that end up being extraordinarily hard hit by the corona virus and the economic slowdown.
If you nevertheless wish to invest in individual equities, we generally recommend that you focus on quality equities, which is a term for companies that have low levels of debt, stable earnings growth, etc. Such companies will generally be better equipped to survive difficult times. Quality equities can be found across all sectors and regions, though perhaps particularly in the IT sector.
Should investors have foreseen the corona crisis?
Should investors have foreseen the corona crisis? Just a month ago, we at Danske Bank had not imagined the situation could deteriorate so profoundly for either society in general or the financial markets. Few, apparently, had expected this turn of events, including the Danish authorities and the Danish healthcare system, and the same more or less applies to the rest of Europe and the US. The common perception was that we would be able to prevent high levels of contagion on our shores, and global equity markets in fact hit record highs as late as 19 February this year, just a few days before prices began to tumble. At that point, data from China indicated they were close to turning a corner in terms of new infections, while a string of other factors in the global economy provided grounds for optimism.
Furthermore, the coronavirus is not the only factor pummelling the financial markets. Shortly after the coronavirus erupted, Russia and Saudi Arabia decided to engage in an oil-price war that prompted historically sharp falls in oil prices and pushed an already fragile equity market over the edge. Falling oil prices hit energy companies and credit bonds issued by these companies, which further increased the widespread stress in financial markets and had a negative impact on equity markets.
Many have described the market for credit bonds – ie, corporate bonds and emerging market bonds – as stressed. What does this mean and why is it important?
The corona crisis and the oil-price war have, as mentioned, not only hit equity markets, but also the market for credit bonds, where we have seen pronounced price falls in corporate bond prices, which in turn have reinforced price falls in equity markets. This is because corporate bonds are generally illiquid – in other words, they can be difficult for investors to sell quickly. The same holds true for emerging market bonds. In contrast, equities are liquid, so when investors suffer severe losses and have to reduce risk in their portfolios, it is much easier and faster for them to sell out of equities than credit bonds. Thus, the crisis in credit bonds has further exacerbated the fall in equity prices.
However, we expect central banks in Europe and the US – with their massive programmes to buy up, for example, corporate bonds – will help put a damper on the stress in credit bond markets, which in turn should also be positive for equity markets.