Covid—19 and stock markets - A personal view

As we enter another week of confinement across the globe, I wanted to share my view on the rebound from most major stock exchange places last week. And it's not an optimistic one.

After 4 to 8 weeks of global lockdown, we are just starting to see progress in Europe. Yet, we are still very much in the early phase of a slowdown. Across the pond, the US has been hit hard over the past few weeks, and there is little doubt that the wave will keep spreading west, hopefully to a lesser extent.

In parallel, stocks have regained 10% last week on the NYSE and ~9% on the Nasdaq. We observed similar trends in Europe as well.

I do not share that optimism, and seeing valuation trends similar to what they were at the end of 2019 could very well be a smokescreen.

Role of central banks

By all accounts, central banks have reacted outstandingly fast and strong. Just last week, the FED injected $2,300 billions to the system, while the ECB injected 540B€. An unprecedented measure that however comes with three unadressed concerns:

  • These exceptional measures happened very early in the crisis. Their efficiency are then bound to a short-term reopening of the economy.

  • The timing of the announces downplayed some very important macro-economic signals, like the dramatic rise of unemployment in the US (6.6 millions by Apr 9th, up by 100% in just 10 days)

  • The consequences of these measures are still very blurry: how hard will this creation of money impact the economy? How big of an inflation trend will we see after 18 months? How will tax policies be impacted (and consequently the demand)?

Most importantly, after throwing everything on the table plus the kitchen sink, the FED and the ECB are left short of leverages, on what could be day 1 of a long crisis.

Impacts on the economy

Most recent market swings, including the mid-March free-fall have been caused by the Covid shockwave, compounded by a debt scare (linked to oil overproduction).

We are still yet to see the concrete impacts of the lockdown on the "real" economy. This should start this week with the first earning calls around the globe.

I hope to be wrong, but these results will probably be much worse than first hoped, in which case the markets may radically correct their valuations to levels that better incorporate the current uncertainty, as well as an up-to-date estimation of defaults in small to mid-size companies.

Lockdown duration

One of the key to the crisis will be the duration of the lockdown. Unfortunately, european governments keep extending them with no real end in sight. China may also re-introduce them after a recent rise of Covid-19 cases.

The longer the lockdown goes, the worst it goes for the economy:

  • Central banks have few margin of action left (interest rates are too low, money creation at unprecedented levels)

  • Which in turns means that relief funds to businesses may run dry, leading to bankruptcies (or more money creation, that the economy will have to absorb with inflation or tax raise in 18 months onwards).

  • Bankruptcies will lead to higher levels of unemployment, which in turns will deeply affect demand.

In the end, it's fair to say that the levels of capitalization will go down to levels similar to 2016-2017. Volatility will start lowering after both the Covid curves flattens, and the lockdown stops successfully in most places. This could very well not happen before September/October.