The great coronavirus market crash

So it happened. The markets stopped their bull run. Sure, I didn't expect it to be suddenly replaced by one of the worst economic crisis ever, but here we are. So, what now? Well, let me put it straight: we are facing doomsday scenario here. Actually, things might even get worse, at least in some countries.

Let's go with order. The general consensus, with which I happen to agree, is that there will be no V-Shaped Recovery, but rather an L-Shaped Recovery. This is hardly surprising: the virus is still around, only a minority of the world population have been infected and are immune to it, and so we simply cannot go back to normal. We have to travel with the v-brake (pun intended) activated, which would be bad for the economy in normal times, let alone after months during which billions of dollars of wealth have not produced because of the lockdowns. Sure, central banks and governments are throwing in the usual monetary and fiscal stimulus, and more of it might arrive. However, this is not going to help much: in order for a stimulus to work, you need something to stimulate. If businesses cannot go back working at full speed because of the COVID-19 containement measures, not much can be done. Hopefully we will have a vaccine by next year, but it may also be that we won't have one anytime soon and we will have to wait for global herd immunity...

So, we are the middle of the desert, with a punctured tire which we can't repair or substitute, only blow air in it that will come out in a matter of minutes, and the nearest place where we can get some help is many km away. How could things be worse? Well, we might run out of water because we've drank all of it earlier, thinking we would arrive at our destination safely with no accidents. That's the situation highly indebted countries with a sluggish economy are in. Their economy may completely sink, which implies falling tax revenues, and at the same time their public expenditure will go up. Their public debt would become unsustainable. A particularly interesting situation can be found in the EU: countries that kept their expenditures in check during good times will suffer from the crisis, but have the means to survive. Those who didn't...well, they can only ask the former to help them stay afloat. And that's the kind of solution we're going to see. Is this going to end well? I don't think so.

Will the stock market crash?

 
Now, the million dollar question: is the stock market going to crash? People have been asking this question for the past few years, but so far the market continues its bull run. Some really believe the euphoria is going to end very soon. Granted, sooner or later bearish market will kick in, so if there constantly is someone claiming a correction is going to happen, sooner or later we will see someone "predicting" the crash. Markets go up and down, it's in their nature. Telling when they go up or down is another story. So I really don't want to participate in this pointless game. I do want, however, make a broader discussion about stock markets behaviour.

Let's focus for a moment on the American stock market, which is the one everybody's eyes are on. The S&P and NASDAQ are breaking records, and some say companies are overevaluated by euphoric investors. Still, the american economiy is doing good, maybe not so good to enterely justify such a bull run, but it's certainly not completely irrational. There is real growth behind it. Point is, even stock markets of European economies that are not doing good at all are breaking records. Just to provide a couple of examples, the french GDP growth rate is not exactly breathtaking, and Italy is barely growing at all. However, stock markets in those countries seem to not care; the italian FTSE MIB earned almost 30% last year, despite economic and political instability. So why are the investors so optimist? If I had a fully satisfactory answer to this question, I would already be a millionaire. But I do know one thing: the markets are distorted. Think about it: what do investors base their decisions on? Their outlook on the state of the economy? Yes, also. But what else? Interest rates. Investors are betting that central banks will keep their low interest rates policy indefinitely. They feel safe, because they assume the central bank is there to keep them afloat no matter what. If this is not a distortion, I don't know what it is.

Now another question from finance 101: what is it that goes down when interest rates are low, while the stock market thrives? Bonds yields, of course. Including those of sovereign bonds. This is why there are countries like Italy showing increasingly unsustainable debt to GDP ratios while still managing to get away with sovereign bond yields that are ridicolously low* compared to the seriousness of the economic situation. Too bad, there are no free lunches in this world, so someone must be paying the price, and in fact someone is. But this is only an appetizer. As I mentioned, these policies are distorting expectations, and distorted expectations can create bubbles, that sooner or later have to burst. But I don't want to sound too austrian, so let's assume no bubbles are being inflated. We still have to face the fact that sooner or later central banks will have to raise interest rates. How will the market react? And what about the highly indebted countries? The combination of a recession and increasing bond yields could be fatal for them. Sooner or later the bill for the lunch will have to be paid. Try not to be seated at the wrong table when the time comes.

*Source: investing.com