Started on all the markets of the world on February 20 (it had started a month earlier in Asia), the fall in the stock markets was dizzying: it almost everywhere exceeded 30% before returning to around 22.5% on average global compared to the last courses of 2019.
For long weeks, the financiers seemed to ignore the threat of a pandemic. It must be said that they have taken bad habits. Already in 2000 and 2007-2008, the markets were badly shaken, and each time, governments and central banks took the necessary measures to stop the fall and allow a rebound.
Once again, they believed to the end that things were going to work out, either because the health problem was going to be solved by the strict decisions adopted in China, or because strong economic measures were going to be taken.
The New York Stock Exchange was particularly eager to ignore the bad news and paid dearly for it: on February 12 the Dow Jones index of thirty large American stocks broke a new record at 29,551 points, it found itself unless 18.592 on Monday March 23; the S&P 500 and the Nasdaq Composite again broke records on February 19, at 3.386 points and 9.817 points respectively, before finishing on March 23 at 2.237 and 6.860 points.
Soaring magic
This development is very disappointing for Donald Trump. On Friday March 13, half an hour before the closing of the American market, he declared a state of emergency in the United States, which would allow him to release up to an additional $ 50 billion to combat the crisis.
Instantly, the Dow Jones index had registered a strong rebound and, quite proud, the president had circulated a document representing the evolution of the course over the day, with its spectacular final ascent to 23,553 points, all accompanied of its no less spectacular signature.
On Wednesday 18, trading was interrupted for fifteen minutes during the session, when the S&P 500 slipped 7%.
The message was clear: “You see, I speak, I act and right away, it’s better.” This is what Trump has kept saying since he has been in the White House: the proof that everything is fine thanks to me, is that the stock market is going from record to record. The problem is that he has been denied by reality. The March 13 hike was just a flash in the pan. The following week, the Dow Jones lost another 19%.
These days were particularly eventful, as Rebecca Chesworth, ETF equity strategist at State Street Global Advisors notes: “Stocks have become more volatile in recent days. The S&P 500, for example, lost 9% on Thursday, March 12, then regained 9% on Friday, before losing 12% on Monday, March 16. It is the first time since 1929 that the S&P has recorded three consecutive movements of 9% or more up or down over several consecutive days. Three days is the record. “
Wednesday 18 was also a painful day: trading was interrupted for fifteen minutes during the session, when the S&P 500 slipped 7%. It was the fourth time in two weeks that this circuit breaker, introduced after the Dow Jones’ fall of 22.6% on October 19, 1987, had been used.
Extraordinary action
Donald Trump was not the only one trying to stop the descent into hell. On Sunday March 15, the Federal Reserve, of which he cannot stop saying the greatest evil, surprised everyone by announcing that it was reducing its main key rate to 0% and that it was going to set up a system purchase of bonds of at least 700 billion dollars – 500 billion on Treasury securities and 200 billion on mortgage loans.
In the days that followed, all the major central banks made strong commitments, including the European Central Bank which, after initial measures deemed a little weak, launched an emergency plan of 750 billion euros, Christine Lagarde ensuring that extraordinary times require extraordinary action.
Initially, only the stocks of companies directly affected by the consequences of the epidemic (tourism, air transport, etc.) suffered greatly. The fall in oil prices, accelerated by the disagreements between Russia and Saudi Arabia over what to do in the face of falling demand, exacerbated the movement.
Then finally, there was what is called in market language capitulation, the moment when the holders of stocks no longer make distinctions and sell everything. In this context, should we close the markets and wait to reopen them until the spirits calm down?
Close not recommended
The question did not really arise, because this measure is a delicate handling: if the economic and financial environment is really very degraded, the fall in prices will resume when the markets start again and the closure will not have served to nothing; it may even have served only to increase the anxiety of savers and strengthen the feeling of panic.
Who would still want to buy stocks and take the risk of getting stuck when the market collapses?
In fact, closings are very rare on major markets: you have to go back to September 11, 2001 to find a closure of Wall Street (located in the immediate vicinity of the World Trade Center) and May 1968 to close the Paris Stock Exchange. And yet, since these events, the markets have experienced some very severe falls.
Closing in difficult times would be the decision not to take. The great advantage of the stock market compared to other investments is its fluidity: you can enter and exit when you want.
This freedom is essential in an unstable market: who would still want to buy stocks and take the risk of getting stuck when the market collapses? The repetition of crises already has the effect of discouraging investors; there is no need to agitate an additional threat.
The only thing that the stock market authorities can do in times of crisis is what the French Financial Markets Authority (AMF) announced on March 17 for a period of 30 days: prohibit the creation or increase of short positions sharp. This means that short sales are temporarily limited, that is, sales of shares that you do not own.
The technique is very profitable in a period of accelerated fall in prices: we sell shares during the day that we do not yet have but that we hope to find much cheaper before the end of the stock month. This downward speculation, when it takes on significant proportions, maintains and strengthens the downward movement.
U-shaped return
That said, we should ask ourselves about the root causes of the risk of investor fatigue. The current plunge in prices has its origins in a health crisis leading to a sharp contraction in international trade and production.
At present, the extent of the damage cannot yet be quantified. It will all depend on how the epidemic will continue to spread and on the length of the periods of confinement which will have to be decided in the different countries.
Today, all scenarios are considered: recovery in V (sudden drop in activity followed by an equally rapid rise), in W (with a first recovery which would be followed by a relapse) or in U (with a more or less long period of weak growth which would precede the recovery).
Globally, the most likely scenario is the U-shaped scenario, the recovery in a country like China is currently being offset by a deceleration in other areas like Europe or America, and so on. ‘that the entire global economy is in a recovery phase.
For France, the government is currently forecasting a 1% drop in GDP in 2020, instead of a 1.3% growth. But Bruno Le Maire is right, this estimate can only be “provisional”.
From bubble to bubble
If this stock market crisis has an origin external to the financial system, it is not the same of the two preceding ones. That of the early 2000s was due to the bursting of a speculative bubble on the values of what was then called the new economy, that of 2007-2008 to that of another speculative bubble, on American real estate this time, with the unlimited granting of mortgages of a quality more than doubtful.
Each time, these harmful behaviors have been encouraged either by keeping interest rates too low for too long, or by a too lax regulatory environment. And when the crisis erupted, the financial world turned to governments and central banks for help, brandishing the threat of falling economic activity and rising unemployment.
The behavior of the stock market over the recent period is instructive. In 2018, it abruptly stopped its ascent due to fears about the world economy. In 2019, it became clear that these concerns were justified, and we saw global growth slowing sharply.
The central banks, more or less quickly, more or less strongly, did what was expected of them.
Donald Trump had largely contributed to exacerbating concerns in 2018 by triggering a trade conflict with China; this conflict continued throughout 2019, before culminating in a break in December. Brexit also played a negative role in 2018; It remained at the heart of the news throughout 2019. What conclusion have the markets drawn from the permanence of these problems? They went up!
In early 2020, they continued to progress, while in the last days of January, despite too long a silence from the Chinese authorities, we began to fear a large epidemic that could spread around the world.
Central banks, more or less quickly, more or less strongly, did what was expected of them: cuts in interest rates where they were not yet close to zero or even below, massive injections of liquidity and extensive asset buy-back programs (mainly bonds).
Some would also have liked share buybacks, but no central bank has gone so far, with the exception of the Bank of Japan, which has bought shares in ETF shares, these listed funds which aim to replicate the performance of stock market indices.
Helicopter currency
Central bank actions are usually primarily aimed at helping organizations that help finance the economy. This time it could be otherwise. It is a question of directly reaching economic actors, individuals or companies, who do not issue bonds.
The idea was pictured by economist Milton Friedman in the form of money dropped by helicopters. This is somewhat what is currently being prepared with the action plans of the various governments, in the United States, in France or elsewhere.
Central banks will not pour money directly into the population; States will do it. In doing so, they will increase their debt, but the central bank will buy it back and monetize it.
Low interest rates, an economy that should start again as soon as containment is over because economic agents have been artificially kept alive, that should allow the stock market to restart. A dramatic rebound has already registered after the March 23 low in the United States: that same day, the Federal Reserve announced an unlimited asset purchase plan and two days later an agreement was reached in Congress on a massive $ 2,000 billion support plan. In three sessions, despite a catastrophic and unprecedented increase in the number of jobless claims (3,286 million in one week!), The Dow Jones recovered 21.3%; such a rapid recovery had not been seen since 1931. In Paris, the CAC 40 arrived on Thursday 26 at a level 25% higher than its low point of March 16.
But don’t be fooled: there can be no lasting recovery until the epidemic is in a reflux phase. And there is an engine that the market will not find immediately: that of share buybacks and dividends. In the United States and Europe, the list is growing every day of companies that reduce or stop them to preserve their cash flow. In France, Bruno Le Maire warned big companies that they should make the choice: either benefit from state support or pay dividends, they cannot do both.
Not all large companies paying dividends will be eligible for the € 300 billion state guarantee on cash loans. Cash must go primarily to employees and investment. # COVID19 pic.twitter.com/JP49xrcMnh
– Bruno Le Maire (@BrunoLeMaire) March 27, 2020
In these conditions, the ascent may lack power, after the first bursts of exit from the crisis. But perhaps then we will return, especially across the Atlantic, to a healthier situation than that which we have known in recent years, with gigantic share buyback programs, the amount of which exceeded that of the sums collected by companies which go public or carry out capital increases. The stock market was no longer used to finance the economy, it only benefited.
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