COVID-19 and the Stock Market Drop

Last Thursday, the New York Stock Exchange witnessed its biggest collapse since 1987. According to Forbes, the 20 richest people in the world lost almost $78 billion in a single day. The bearish trend triggered by the coronavirus has been observed all over the world. We are dealing with a classic “black swan” – an unpredictable, random event, the consequences of which scale exponentially, causing both negative, but also positive transformations, Vladimir Milovidov, head of the International Finance department at MGIMO University, said in an interview with vadaiclub.com.

 

What is needed to turn the tide?

It is very difficult to talk about any one tool or set of tools that could somehow radically change the situation. Since the beginning of this year, there have been two dates when the US financial market reached “local highs” – January 17 and February 12. On these days, the Dow Jones Industrial Average hit 29,348 points and 29,551 points respectively. WHO statistics on the spread of the COVID-19 virus began on January 23. That is, the first maximum was before the information about the sick people in China began to arrive, while the second came at a moment when there were already more than 50 thousand sick in China. The mood began to change sharply, against the background of the first news about the growth of cases in Europe, especially in Italy – on February 23. From that moment, one of the key world stock indices fell by more than 8,500 points, or almost 30%. As we see, neither verbal intervention nor the actions of the authorities can help. Moreover, the reduction of the Fed interest rate two times in a row to 0-0.25% was initially perceived by the markets as a manifestation of the weakness and fear of the American regulator. Apparently not by chance, at the height of the exchange trading on March 16, Trump tweeted: “God save America.” One can only add that not only it one.

The situation that we are observing is the realisation of accumulated fears regarding the possibility of a recession and the fall of the stock market, which had been growing for a record 10-years. An interesting point: the negative correlation of the Dow Jones index and the number of people infected with the virus in the world since January 23 is about 0.6 (the more patients, the lower the index), and the correlation with the dynamics of Internet queries of the world population about coronavirus is also negative (the higher the popularity of the request “Virus”, the lower the index), but already 0.9 (max = 1). Of course, these figures should not be exaggerated, but it seems that market participants are more responsive to the deployment of global fears than to statistics. This is already from the category of psychology and irrational choice.


Will the additional financial injections announced in the US and the EU slow down the fall? How long does it take to return exchange indices to their previous positions?

For the foregoing reasons the answer, unfortunately, is disappointing – no. Or at least not soon. Financial injections, monetary easing, and a reduction in interest rates are classic means of holding back a recession, that is, a situation in the economy where growth rates slow down, business activity decreases, demand falls, business activity cools down for objective cyclical reasons. Nobody has cancelled the economic cycle, and its mechanisms still work. The problem is that the influence of the coronavirus on the financial market is not economically supported. A sharp reversal of the situation occurred despite a favourable background of employment growth in the United States, with record low unemployment, a GDP growth rate of more than 2%, and extremely low inflation. And the fact is that the Fed was in no hurry to lower the interest rate, despite constant pressure from Trump. The regulator left some room for manoeuvre, which would be required if there are signs of a recession. Now they’ve run out of ammunition against the background of market hysteria and fears of the virus. Of course, the suspension of factories in China, quarantine in Europe, all this can lead and will certainly lead to a decrease in economic growth. But the tense is important: will lead, not have led. Losses will still be counted. Recently Trump confidently stated that while unavailable due to quarantine downtime, significant unrealised demand could be accumulated and as the panic subsides, the economy could really come to life, and indicators of economic activity will go up sharply. This scenario has a right to exist and could probably really be realised already in the second half of the year. But this is only one and exclusively optimistic scenario.

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Will the stock market crisis trigger a more global economic crisis? Why?

Not so much the stock exchange crisis in itself, but the reaction to the spread of the virus. This is another scenario, and it is one where the paralysis of economic activity in the leading countries of the world (trade, offices, enterprises, banks) aggravates the debt problems of private companies and the growth of public debt. Inefficiencies are likely to appear (enterprises with low profits, high debt, low productivity and overblown costs), which will affect the banking sector. Forcing the active population to take holidays can lead to lower incomes and savings, which can also hit the financial stability of banks that keep deposits. Demand for labour will begin to decline, unemployment may begin to grow. And so actually this lump of problems will fester, worsening in scale. This is what frightened the market. Moreover, the European monetary authorities, and now the American ones, have actually exhausted their reserves stimulating the economy.

Interest rates have almost no prospect for reduction. You can pump money into the economy, but as we saw before, most of these funds simply inflated the prices of financial assets. Now they have depreciated, causing social consequences. In the United States, almost everyone who has individual pension plans (accounts), so-called 401Ks, has lost substantial funds, because they were invested in securities. What remains? As always, hope. For example, that the depth of the fall of the Chinese economy, where it all began, will not be as significant as it may now seem.

But not everything is so sad. We are dealing with the classic “black swan” – an unpredictable, random event, the consequences of which scale exponentially, causing both negative, but also positive transformations. In a way, we are already living in a new reality, and after the epidemic is over, this will become even more obvious. For example, everyone in all countries may like working remotely; it will be effective for employers and modern information technologies will be even more involved. The longer the current situation lasts, the less likely offices will be in demand, and the nature of work and lifestyles will begin to change... So let us say hello to a brave new world.
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Infographics
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