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Are we close to capitulation?

This week has been really tough: Global equity markets have fallen c.17% this week. However, this does not include this morning’s European rally of some 8%, which if it holds for the day will make the week’s performance look a lot better.

The week started-off with a fierce oil price drop on Monday, caused by OPEC and Russia failing to agree on a production cut in response to the virus. This would have led to a bad day in markets in any event but as this came on top of all the bad news and confusion around the virus, the day was an exceptionally bad one for stocks.

Trump travel ban

On Monday night after markets closed, Trump promised that on Tuesday there would be a big announcement from him and so markets rallied on Tuesday. However, no speech came. When Trump finally did speak on Wednesday evening, he gave an underwhelming speech, announcing a travel ban for incoming Europeans. Beyond the travel ban, the economic measures he announced were modest and vague whilst his speech contained factual errors. What was required was a presidential performance, but he looked rattled.

Finally, on Thursday the ECB stunned markets by leaving interest-rates on hold, though to be fair to the ECB it has limited easing room left and it did pull out every other weapon in its arsenal.

So, where does that leave investors?

It is important to remember that markets have had three crashes in the past: 1987, 1998 and 2011. In each case the US stock market was up 18%, 38% and 27% one year on. Historic parallels cannot play out exactly as happened in the past, but it is good to know those numbers when making any portfolio decisions.

It has become obvious that markets behaved in an almost panic like fashion on Thursday. Analysts at Goldman Sachs highlighted weak liquidity and JP Morgan noted that it was seeing signs of capitulation. Furthermore, the Goldman Sachs Global Risk Appetite Indicator, which is calibrated such that levels below -2 historically indicated better risk reward dynamics for taking risk over a 12 month horizon, is now -3.5. It only fell to -2.96 in the financial crisis. So, it looks like there is at least some panic but previously this has never been the right time to sell for long term investors.

Roche receives FDA approval for testing

Whilst it is very easy and correct to be concerned about the effects of COVID-19, good news regarding the virus can also emerge. On Friday morning Roche, a major Swiss pharmaceutical company, announced that it received emergency approval from the FDA for its COVID-19 test. Potentially, this is very important. So far testing has been done manually in research labs but, reportedly, Roche’s test can produce a result 10 times faster than those tests currently available. For example South Korea, the poster child for testing, has only conducted a total of 200,000 tests over the past week. Reports are that Roche’s new test will be available on Monday and could enable testing to be carried out on a greater scale.

The reason this is important is that aggressive and broad testing allows society to quarantine those affected whilst those unaffected can keep the economy going. The shorter the time it takes to produce a result, the less time people who test negative must spend in self-isolation, so it might reduce the economic pain it takes to mitigate the virus.

© 2019 GWM