This is not the bottom. It’s also not the end.

It feels like I wrote my previous note weeks ago and that probably has something to do with the fact that we have had many months’ worth of market events condensed into just a few days. Markets are rarely so chaotic that events like central bank rate changes and major economic data releases are forgotten within minutes. Many of the actions we expected have now materialized. The detail on central bank action is somewhat irrelevant – suffice it to say that this week almost all traditional stimulus tools were exhausted by all major central banks. Monetary policy has been eased completely. Aside from the US, we have essentially reset to zero. Additionally, substantial aid packages were announced by various governments including Italy, the UK and the US. It is hard to believe that since my last update we have had 3 of the most chaotic trading days in financial markets history. Some major indices were down as much as 17% in a day. By some measures the extremes of 2008 were surpassed. The week ended with a substantial rally in the US following Trump’s declaration of a State of Emergency, which he undoubtedly opted for in order to fast-track the flow of money.

Let me cut to the chase: I do not believe that we have seen the bottom. I firmly believe that this situation will continue to deteriorate before it improves, and I am referring to both the COVID-19 pandemic as well as the state of financial markets. I take limited solace in the fact that the entire planet now seems to be as worried as I have been for quite some time. Many have gone from casual indifference to complete panic in the space of 1 week. I therefore also think it is important to say that I do not believe this is the end. It’s going to be a bumpy ride, but there will be light at the end of the tunnel soon. In a nutshell, here is why I do not believe this is anywhere near over yet:

1. Equity market valuations are only just in line with where they were in December 2018. We are still coming off an incredibly high base. Astonishingly, the S&P500 is not yet officially in a bear market, although many other major indices now are. Some tech companies in the US, including house-hold names like Microsoft are positive YTD, which is quite remarkable. Many of these stocks have only given up the gains made over the last 6-12 months. Bottom line: I would not be surprised to see some of these stocks down another 10-20% from here.
2. Stress fractures have been revealed this week, and it is highly unlikely that they disappear as quickly as they emerged. The credit market is beginning to come under a huge amount of strain (largely fueled by the dramatic sell-off in oil which has sent shock waves through the US high yield energy sector). I believe we will see a fair amount of credit events as a result of this. It remains to be seen how much contagion there is into other sectors. Why is this important? Because a credit crisis could turn 2020 into another 2008. A huge amount of risk has been transferred from banks to corporates over the last 10 years. While it is unlikely (I’ll say impossible) for a major bank to default, it is possible that a few major corporations could.
3. Markets became dislocated and dysfunctional over the past week, hopefully temporarily. It is unlikely that a few days on, purely as a result of a declaration of a state of emergency, this dislocation corrects itself completely. A large motivator for the amount of intervention seen was the need to stabilize liquidity. If you were trading last week you will know that liquidity has not been this poor in many years. It is hard to say whether the relief at the end of the week will be  sustained.
4. The likelihood of global recession has increased. Bear in mind that only a month ago most commentators believed global recession was unlikely. That balance is now 50/50 at best with many, including myself, believing recession is quite possible. Everyone seems to be entirely focused on the virus. The belief seems to be that all will be dandy as soon as the virus is under control. If/when we manage to get the virus under control we will start working through the real economic damage. That will unfold slowly. It is almost guaranteed that growth and earnings data coming out over the coming months will surprise to the downside, and the market will react to that.
5. Volatility peaked at 75 this week (in 2008 it touched 80). It is highly unlikely that we have seen the bottom of this crisis in the same week that we saw the highest volatility in 12 years. One thing I am certain of it is that volatility will remain elevated for a number of weeks at least.

For the rest of this note I will stick to the format of my original commentary.

How bad can this get?

• I maintain my initial assessment from January and still believe overall markets will ultimately sell off 25-30% at least. Staying with the S&P500 as an example that would mean we could see levels as low as 2300. My worst-case scenario is currently 2000, although I am hoping things stabilize before that. It is worth noting however, that 2000 is a level seen as recently as 2016. It is by no means impossible.
• We need to keep an eye on the credit market as well as general liquidity and functioning of financial markets. Last week some of the most liquid instruments on the planet became temporarily un-tradable. 

What actions are on the horizon?

• As expected, central banks have rolled out rate cuts and stimulus in full force with the BOE joining the party on Wednesday (emergency 50bp rate cut and 100bn stimulus package). All of these measures, as ineffective as they are in terms of direct impact on a virus, provide much needed respite to markets – markets would likely be completely decimated at this point without the actions we’ve seen
• I have unfortunately been a prophet of doom when it comes to major shutdowns for quite some time and this week we started to see these shutdowns pick up pace. Spain could look like Italy next week. There will be further lockdowns of entire countries, further cutting of services, more travel bans, more business contingency planning, more working from home. There will be variations from country to country, but expect our overall lifestyles to be very different for the next month at least

Keeping track of the game changers:

1. Confirmation of seasonality, or lack thereof is still my number 1 game changer. As discussed previously most of these types of viruses tend to fade in the summer in the northern hemisphere (SARS, MERS all did). The base case here is that COVID-19 will also fade as we approach June/July. If it doesn’t, all bets are off.
2. Effectiveness of lockdowns: It is still too soon to tell whether Italy has managed to make a dent in the rate of spread – they are the first country ever to attempt a quarantine this large. If it works, hugely positive – if not there’s a renewed negative feedback loop. It is hard to find reliable info with all the alarmist reporting, but I am quietly optimistic that Italy will start seeing a positive impact next week. It is also noteworthy that South Korea seems to be getting things under control. That is significant because South Korea would be the first country similar to European countries to control the outbreak (we can’t compare Europe/US to China).
3. Vaccine/treatment: Obviously any signs of either on the horizon will be a positive. I am asked about this frequently and the reason this isn’t on the forefront of discussion is because it’s not a quick fix either way. Natural fading would be infinitely more effective than developing/rolling out treatment. About 10 major companies are currently working on this (Gilead have started a 600 person trial the results of which are expected in May). Make no mistake, any positive news (despite the delay in taking effect) will have a huge impact on markets.
4. Inflexion point in the US: Currently the most effected regions are China/Italy/Iran/South Korea. The US is still in its early propagation stage. I expect this to change as I do not think the US is well positioned to deal with a crisis of this magnitude (leadership, politics, make-up, health care, etc). The US spilling over is one of the negative game changers I have fully expected for a number of weeks now.

Opportunities and timing:

• I still believe it is too soon to add substantial amounts of risk. If you have the stomach for some valuation swings, and are prepared to take a long-term view, then some good value propositions are starting to emerge. Make sure you stick to companies that are stable enough to weather a serious storm. But if you are already sitting in cash, then there is no rush. There is little risk of you being left behind in a bull-market infused dust cloud at this stage.
• When the time comes, my various buy-recommendations are currently unchanged from last week

On a personal note: The reports out of Italy and Iran are disturbing and hard to digest. I would like to encourage you all to think ahead to what will ultimately count. And my reading of that is that we start to think about and protect those around us who are either vulnerable or do not have youth on their side. Most of us will be fine. Many of our children will contract COVID-19 without us knowing about it. But we do need to start thinking about our parents and the elderly community in general. We can be responsible without being scared. Follow the advise of your government. Use common sense. Help the elderly isolate as much as they can. In an ideal world we keep them completely protected for the next 2 months. Have things delivered to the door, wash your hands regularly and start to think about the risk of your children passing this thing on to your parents. I know it’s an awful thing to think about but we need to get real. If we act decisively we have a much better chance of getting through this.