Covid-19 is Infecting Markets as well as People: how can Equity Investors Respond?

Financial market investors are not normally concerned about viruses, even pandemics. Though pandemics can cause unexpected business disruption and influence the supply and demand for goods, services and commodities, their effects are usually temporary (see: chart on world epidemics and global stock market performance). This was the case with the original SARS (Severe Acute Respiratory Syndrome) outbreak in 2003, the first incarnation of Covid-19. SARS was estimated to have cost businesses $50bn in output globally, a relatively small amount that had no lasting effect on the global economy, and financial markets rebounded in just a few months.

What has changed?

Governments, businesses, financial markets and financial market institutions have all been surprised by the far-reaching effects of the Covid-19 pandemic, effects that we will feel for many years to come. Until Covid-19 modern pandemics were contained quickly, limiting their impact on businesses. Covid-19 has spread around the world and infected large numbers of people, killing many thousands and causing significant disruption to the lives of billions. As a result, there is no other modern pandemic against which its economic effects can be compared.

Equity markets

A key feature of the equity market response to the virus is volatility, including substantial intraday movements. Equity market volatilities are at levels not seen since the global financial crisis of 2008. The problem is the absence of reliable information on the economic effects of the virus, as a result investors have resorted to ‘momentum’ trading, using broad signals, such as central bank or government stimulus responses, or news regarding the spread of the virus, to influence their decisions. Markets have tended to over-react, rising or falling more than the economic fundamentals indicate. Simple strategies, such as ‘buy the dip’ dominate, with investors rapidly switching their strategy from sell to buy, to exploit excessive falls, while precipitating a new fall as soon as further adverse news comes to light. The secret to success is the ability of an investor to predict the turn of a market, up or down and to be prepared to buy at the bottom when others are unwilling to do so.

Though much of the movement in equity markets was momentum based, sector specific changes occurred, mirroring the positive and negative effects of the virus on business sectors. Sectors adversely affected by the virus (the majority) saw falls in stock prices (e.g. travel, tourism and financial service sectors), the few that benefitted saw big rises. Two sectors that benefitted from big gains in equity values were non-perishable food, because of the surge in demand from consumer panic buying and the Biotech sector, particularly in the companies working on a vaccine.

How should investors respond?

In a volatile market it is tempting to cash in your equity investments and leave. However, with central bank interest rates falling, there are few options available that will offer an inflation busting return. Here are some strategies to consider:

  • Retain investments in equity stocks that are more resilient to the economic effects of the pandemic. The pharmaceutical and grocery sectors (e.g. supermarkets) are obvious choices, but also consider technology stocks. As home working increases in popularity people need more and more technology, both in terms of hardware and software. 
  • Avoid high Beta stocks. A significant slowdown in economic growth is expected, for several years. Possibly even a global recession. This means that industries like construction and the luxury goods sector are likely to suffer for a prolonged period. 
  • Diversify into other asset classes, like commodities. The virus has caused some commodities to fall in price, like oil or copper (a common metal used in manufacturing), while others have risen. Gold remains a relatively safe hedge against inflation and some analysts are predicting further price rises. Many food related commodities are also doing well – for example wheat and rice, as a result of dried food hoarding by some consumers. In addition, there has been a significant rise in the price of frozen concentrated orange juice, as consumer demand for immune boosting food and drink has increased. 
  • Keep a cool head and take advantage of market over-reactions. For example, highly rated sovereign bonds are generally used as haven assets in a declining equity market, but during periods of high market stress, some investors were forced to sell sovereign bonds to raise cash quickly. This has provided other investors with an opportunity to take advantage of higher than normal yields. One example is the US Municipal Securities Bond (Muni) market, where stressed selling pushed yields up 100bps or more.

What next?

We do not know when the pandemic will end to how serious it will be both in terms of the human and economic health of our world. But one thing we do know is that even a pandemic brings opportunities as well as threats to businesses and financial markets. Investors that stay calm and make wise choices can not only protect their capital but generate significant returns. Returns that will hopefully be used to help build our global economy and mitigate the effects of future pandemics.

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