Markets surged on Monday following global announcements of policy easing. This is in line with my 13 February expectations that Covid-19 was unlikely to end Tina (There Is No Alternative), a market regime where low yields have allowed equity valuations to decouple from economic performance. Based on policy makers delivering the promised easing, I am expecting the rally to continue.
First, while Covid-19 is highly contagious, it has a low mortality rate. A global pandemic is underway and countries with low infection rates likely have not implemented comprehensive testing. As a result, the consensus mortality rate of about 2% could be an overestimation. South Korea, which has implemented mass testing and has the highest infection rate outside of China, has mortality rates of about 0.5%, though of course this could change (Chart 1).
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Markets surged on Monday following global announcements of policy easing. This is in line with my 13 February expectations that Covid-19 was unlikely to end Tina (There Is No Alternative), a market regime where low yields have allowed equity valuations to decouple from economic performance. Based on policy makers delivering the promised easing, I am expecting the rally to continue.
Chart 1: South Korea – New Infections and Mortality Rate
Source: Macro Hive, Humanitarian Data Exchange
First, while Covid-19 is highly contagious, it has a low mortality rate. A global pandemic is underway and countries with low infection rates likely have not implemented comprehensive testing. As a result, the consensus mortality rate of about 2% could be an overestimation. South Korea, which has implemented mass testing and has the highest infection rate outside of China, has mortality rates of about 0.5%, though of course this could change (Chart 1).
Second, the public reaction seems out of proportion: most of us will contract Covid-19, but we’ll experience only mild symptoms and build some immunity. A panic epidemic is underway as the public is going through a process similar to Kubler-Ross 5 stages of grief: denial, anger, bargaining, depression, and acceptance. As Covid-19 new infections news becomes a new norm, and as understanding of the disease improves, the public is likely to move to acceptance and the panic epidemic to subside.
Chart 2: Initial Unemployment Insurance Claims
Source: Macro Hive, Haver
Third, there is so far no evidence that Covid-19 has caused irreversible economic damage in the US:
• Chinese daily data on intracity travel, a high-frequency proxy for economic activity, shows stabilization. Yet China’s leadership is likely concerned by the long-term impact of prolonged factory closures on China’s global economic role. The leadership is also likely keen to show that it has the epidemic under control. Under China’s top-down governance system, this suggests continued recovery in production and the February PMI print could well turn out to be a trough.
• Covid-19 could have lasting consequences for the US if it led to a jump in unemployment or in financial distress. But initial unemployment claims are not increasing and there is no sign of widespread financial distress (Chart 2). While the spread between higher and lower rated high yield corporate bonds has widened, which in the past has been an indicator of financial distress, the widening has been limited (Chart 3).
Chart 3: High Yield Bonds, OAS
Source: Macro Hive, Koyfin
Fourth, while monetary policy easing cannot conjure missing inputs out of thin air, it can alleviate the impact of a decline in cash flow by making it easier and less costly to borrow. In addition, fiscal pump priming can make up for shortfalls related to Covid-19: Italy has already announced EUR3.6 bn in tax credits and cuts and additional health spending. Usually a paragon of fiscal virtue, the European Commission has praised these moves and announced that this time around it is preparing a round of coordinated, pan-EU fiscal easing.
Fifth, markets are forward looking. While economists are busy lowering their growth forecasts, from a market perspective what matters is not so much the initial decline but rather how fast the economy can recover. Of course, a very deep or very long decline in economic activity would leave economic scars and prevent a bounce. But there is no evidence that this is happening.
Long periods of very low market volatility interrupted by short burst of exploding volatility are likely to be the new normal. Through very loose policies, global central banks have repressed yields and market volatility, which has led investors to sell volatility to improve returns. The hedging of these positions tends to amplify market movements. In addition, it is likely that systematic strategies, including momentum, have resulted in highly crowded positioning. There is a risk, therefore, that the factors that brought about a very fast market decline could reverse and bring about a surprisingly fast market recovery.
The main risks to this view seem to me to be political. In the US, large shortfalls in medical insurance coverage create a risk that the epidemic could benefit presidential contestants perceived to be hostile to business. In the EU, illegal immigration could turn out to be a vector of transmission and therefore fuel support for populists and anti-EU parties. And, of course, limited, short-term market selloffs are likely as countries improve testing, more new cases are picked up, and the public works its way through the Kubler-Ross stages. Overall, though, baring adverse political development, continued market recovery seems to me more likely to continue than not.
In the longer run, there will come a time when TINA stops working. But how this could come about is a topic for a future post.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)