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  • William Bourne


The sharp market falls this week are not unprecedented and from a purely technical sense are healthy.  It is in the nature of bull stock-markets that greed takes control and drives them too high.  They need occasional corrections to keep them in touch with reality. The cause of any pull-back may be based in reality, for example fears of recession affecting corporate earnings, or it may be more based in investor psychology.  Coronavirus may or may not turn out to be a case of the latter.  Either way, their job of reining back the bull market is done. But every now and then something more serious happens and the result is a bear market: fear takes over from greed.  It tends to feed on itself and drive markets down to levels which are demonstrably cheap but investors are still unwilling to buy.  It may seem strange to ask whether we are in a bull or a bear market when the US is this morning down 20% from its peak, but there is still plenty hanging in the balance. The prognosis for coronavirus, now declared a pandemic, is one input but nothing like as important as the reaction the authorities have chosen to make.  The very desperateness of their attempts to prevent its spread has at a psychological level led to suspicions that ‘they know something we don’t’ and at an economic level to a collapse of demand as well as supply side problems.  It raises the likelihood of a recession considerably - our central scenario had previously been that the world would escape one, whereas now we think that is unlikely. On the other hand monetary and fiscal policy is clearly supportive, the former already at full bore in much of the world (N.B. not yet the UK), the latter still limbering up.  If they are the cavalry riding to the rescue, will they be in time and will they be effective?  Monetary policy in the traditional sense of cutting interest rates has little room for manoeuvre because they are already so close to zero, but if a more radical approach of putting money into the hands of those who will spend it is adopted the effect may be greater.   We view fiscal policy expansion as inevitable, as there is a political need to put money into the pockets of those who have lost out over the next ten years.  But will it be in time to stop a recession?  The US has led the way, and – particularly with an election coming up – may escape, and after the Chancellor's budget yesterday has put the UK firmly on a similar path.  In our view it is the right course to take.  The problem is that there will be a lag of 12 or more months before these announcements have any result.  While it may well be too late to avoid a recession, these actions should in the longer term act as a stabiliser. The curveball which spooked markets last weekend was the collapse of the Russia/OPEC oil cartel.  Perhaps we should have expected a world which has one eye on deflation (see previous blogs) to see the 20% fall in the oil price as a further step in the wrong direction.  But we rather think it is more the excuse for this week’s correction than a real cause for concern. A sharp fall in oil is a clear transfer of wealth from oil producers to oil consumers.  There will be winners and losers, but overwhelmingly the winners are on our side - consumers who drive cars or beleaguered airlines.  It is the converse of the oil ‘shock’ of the 1970s.  Of course, it will take time to play out but if the oil price stays low for long it will help mitigate the effects of any recession. Should investors buy or sell from here?  We don’t yet know what course the virus will take or, more importantly, whether Trump’s measure to ban transatlantic travel between much of Europe and the US will be followed by others.  Even if there is more to come and a global downturn ensues, we’d expect governments to react decisively to loosen fiscal policy and stimulate growth.  A lower oil price will be a helpful factor. The real threat is what happens if these measures don’t work and deflation takes over.  Japan has still not really escaped after 30 years and Europe, for example, has inflation levels perilously close to zero.  That is the real bear market scenario.  Again the authorities will strive to escape but maybe the collapse in US 10 year bond yields from 2% to 0.5% - predicted by Linchpin almost a year ago - in not much more than a few weeks is giving the markets’ verdict on their chances.  We still believe they will hit zero.

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