The darkest hour is just before dawn

6th April 2020

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The next two weeks look set to be amongst the toughest in living memory for both the United Kingdom and the United States.

Both nations are facing into the epicentre of the Coronavirus crisis even as continental Europe shows for the first time definitive evidence that it is moving out of it.

Markets are broadly recovering buoyed by improving financial conditions and the evidence of recovery in key nations.

However, the hospitalisation of Boris Johnson provides a clear reminder of the unpredictability of this disease which could make fools of anyone who believes they know the path it will take.

In terms of the virus itself, the biggest economic risk now is in the United States. Unlike Europe the government’s response in America has been disjointed and marked by the contradictory advice of President Trump.

There is also concern about whether the flaws in the fiscal bail-outs, which are preventing them reaching small businesses, are being acknowledged by the White House. A reporter who sought to raise the issue late last week was literally shouted down by the president. In contrast in the United Kingdom chancellor Rishi Sunak has moved fast to lift the obligation that small business loans come with personal guarantees and remove the requirement for companies to have sought conventional finance first.  These measures have to work to avoid a depression and a bland denial from the White House will not solve the problem. For the moment we are continuing to believe that sense will prevail, largely as a result of the efficient State-level responses being carried out particularly in New York.

Whilst predicting the end of this crisis may seem shall we say rather brave to most of us, Deutsche Bank has had a go. It has focused upon the date where ‘two generations’ of the disease will have been contained by the lock down. This is to say those who have had it have infected their immediate family and they in turn have been contained.

On this basis it makes the following forecast.

For investors though we can have growing confidence that the virus will ultimately be contained within a reasonable timeframe.

This, coupled with enormous central bank buying, has brought a greater level of stability to the financial system. Measures of financial stress are falling and the Vix index, which measures market volatility, also looks to have peaked.  

The key focal points this week will likely be around the path of the virus in the United States, the relative effectiveness of government schemes at getting money to businesses and individuals and most importantly oil.

It is easy to forget that in the midst of this medical emergency an oil crisis has been engineered by Saudi Crown Prince Mohammad Bin Salman and Russian President Vladimir Putin. President Trump raised expectations last week that a deal was close that would lift the oil price back up to more manageable levels. However, it has not been forthcoming. The oil price at this level has a number of important implications. Firstly, it hurts stockmarkets with high oil components in their indices – such as the United Kingdom.

Secondly, it places US shale oil exporters – a major component of the US bond market – under stress. Many of these oil producers are now terribly close to losing money.

Whilst the level of $27 at the time of writing is dizzyingly low for oil, we must remember this is not even the real price. The Saudis are selling oil to Europe at a discount of around $10 currently. The industries that could usually benefit from this can gain little – planes are grounded. Until this situation resolves itself, we can expect to see outperformance from those economies which have a stronger healthcare and technology component than those with raw materials and oil components. However, as the crisis does resolve itself, we believe there is space for a very sharp recovery in these ‘value’ stocks.

Finally, as we all begin to talk with our clients about the possibility of buying shares again let me leave you with these charts from State Street. They make a very simple point. Right now, shares are far cheaper than bonds and on a cyclically-adjusted basis cheaper than they have been for the past ten years. If we are able to be of any help communicating this opportunity to clients at this delicate time do let us know. 

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