Crazy volatility in a very difficult time

31 March 2020

The VIX index hit 83% on 16 March, which was the day when the S&P 500 slumped 12%. That beat the VIX’s previous record, set back in 2008. We titled our previous edition “Cuts in interest rates will not be enough to deal with this crisis”, and events proved that right as governments across the world showered billions of helicopter money on individuals and businesses affected by Covid-19. Unlimited central bank liquidity has helped to lift equity markets off their lows.
In the meantime, millions of highly anxious people are in an apparently unlimited lockdown. The magic of modern medicine is not as powerful as all that, and it turns out that we are short of the few things that do work, such as ventilators and even basic protective and other equipment. The markets will remain in the same state of fear until they see a way out of the pandemic; the 34% correction to the S&P 500 from its highs took just 33 days, and of course we do not yet know whether the 2,237-point low will remain the bottom.

The statistics on the pandemic are a total mess. National comparisons of coronavirus cases are meaningless, as they hinge on the number of testing kits available. There is a huge gap in tests carried out in France and Germany, for example. We have searched in vain for a country that has established a representative sample of the population that would enable us to track the spread of the disease scientifically (we used to work on the Nielsen Scanning Panel). So far we do not know what the best way of combatting it is, either. China, South Korea and Singapore all risk renewed outbreaks, which is why they are being so careful about returning to normal. The Netherlands and UK have backtracked from ‘herd contamination’ strategies, which could have proved very costly in terms of lives in a context of health system overload. At the end of the day, getting through this crisis will require a miracle vaccine, a miracle cure or herd contamination, which is what is actually happening without anyone admitting it. Once more than half of the population has been exposed to the virus and has developed antibodies, the epidemic statistically ends. We are all waiting on antibody tests rather than tests for the infection itself; they ought to arrive in a massive scale soon and – one hopes – immune individuals will then be allowed to return to work and something like a normal life. Individuals that do not have antibodies but are deemed low-risk could then follow. Statistics on the proportion of immune individuals would be welcome in the meantime.

Having slumped 34%, as we have seen, the S&P 500 is down 25% at the time of writing. By sector, the biggest corrections concern energy, finance and everything connected with travel and holidays. Netflix is doing well, with so many people having nothing much to do other than watch TV. Bond markets have been disrupted, and spreads as high as 12% on junk issues are kindling fears of imminent bankruptcies. Central banks have already pumped in .7 trillion in new liquidity and many governments have launched stimulus packages to protect jobs and firms.

Consensus forecasts and other economic indicators are completely useless at the moment. We have referred back to the 2008 crisis to pencil in a 21% drop in US profits this year and a 15% rebound in 2021. If we use 1.38% for our 30-year rate, we obtain a year-end theoretical objective of 3,030 points for the S&P 500. The market could be expected to hit that level as we come out of this crisis. This valuation has prompted us to switch from an underweight equities allocation relative to the benchmark to an overweight allocation, and in any case our allocation had dropped to 30% because of the correction. We expect to lift that allocation 5% by placing buy orders from 2,650 points upwards. That was the previous low at which we got in. We would also ask what is going to happen in the end to all those billions showered on our economies: will they end up as higher consumption amid shortages of supply, triggering significantly higher inflation?

We wish all our readers good health and the energy we will all need to get through this period.

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