As global markets continue to drop as a result of the Covid-19 crises, Neil Birrell explores how investors can tell when markets have hit bottom...
Markets are moving so fast that I feel I have to time stamp everything I write or say. To stick with that policy, this data is correct as of Friday morning 20 March 2020. Equity markets across Europe are up between 2% and 5%, the S&P futures are showing a gain of 70 points, sterling has jumped 3 cents against the US Dollar and 2 cents against the Euro and the yield on the 10 year gilt has fallen from over 1% Thursday morning to 0.58% - and it wasn't even 9am when I researched those figures!
That might suggest that Friday was a good day to be buying equities and gilts, which is true, over a few hours, but there is no way of knowing if last week (which marked a short-term low in the FTSE All-Share Index) will have been the bottom over any longer period of time. For what it is worth, I do not think it was the nadir of this market fall, there; that should call the bottom, hopefully.
My point to all this is that the only way you can call the bottom is by looking back from some point in the future and pointing to the day. The anatomy of every big market move is different and therefore the lowest mark occurs for different reasons before the recovery comes.
One reason often cited is when "capitulation" occurs, in other words investors collectively throw in the towel and sell everything; when even safe haven assets are sold, when assets that shouldn't be affected by the underlying reason of the sell-off are sold, when panic is setting in. That is also when correlations start centering in on 1 - that is, all moving in the same direction at the same speed.
I thought we might have hit that point on Monday of last week: there were movements happening within markets that were, to me, inexplicable and had all the hallmarks of the point of capitulation or maximum pain! It was also impossible to think why that should be the turning point given the forecast spread of Covid-19 through Europe and the US, even though the data coming out of China and South Korea was improving.
But, there again, why should it be clear? We've never been through anything like this before. If we look at some of the largest stock market falls in recent history, we will see that they were caused by different factors.
The sell-off in the early 1970s came as a result of the oil price jumping from $3 to $12 and the resulting rampant inflation driven boom and bust (nothing like now); Black Friday in 1987 came more from speculative activity reversing (nothing like now), the dot.com bubble needs little explanation (nothing like now); the global financial crisis of 2008; the feared break-up of the Euro in 2011; the taper tantrum in 2015; the end of cycle fretting at the end of 2018… (you get the picture).
They all happened for very different reasons and the recoveries all came about for different reasons - no read over to today is possible.
So, is there anything that we can use as a guide as to when we hit the bottom? I think there are some indicators we can look at.
Firstly, the scale of the spread of Covid-19 is fundamental to how the world economy is going to behave over the coming months and potentially years and that will be a driver of central bank monetary policy, government fiscal policy and how financial markets behave.
If China can be taken as a guide, then assertive action to stem the spread is important and is reflected in markets. The China CSI 300 Index was near highs in mid-January and rapidly fell as the virus issue became clear, as the authorities got to grips with it, the index rallied back to the highs again. Inevitably, though, it has slumped with the rest of the world as the global nature of the problem unfolded.
Therefore, can we assume that as the number of new cases rolls over that markets will rally from that point; no, because we don't know what the economic ramifications are.
Secondly, looking at the economic ramifications is difficult, it is way too early to estimate the impact in numbers, but adjectives might cover it; ‘severe' comes to mind. Given that markets discount the future to one degree or another, forward looking indicators are probably the most useful data points and within those the Purchasing Managers Indices (PMIs) are probably the best, they cover all regions and all industry sectors.
They represent the outlook of business decision makers and likely spending patterns, in other words - what is their confidence in the future, once they start turning upwards, the world is looking rosier?
Thirdly; valuations, when will markets look cheap enough to buy? Unfortunately, that's not obvious either at the moment. If we just stick to equity markets for now, the fact that they have fallen so far does not make them cheaper, the Earnings part of the Price/Earnings ratio will be growing nowhere near the 5 - 8% in 2020 that was expected at the start of the year.
In fact it is likely to fall by 20% or more and dividends are already being cut by companies, meaning the yield support is reducing as well. We simply will not know what company earnings will be and therefore what the market valuation is.
That's lots of don't knows, but then, as I said above, you can't call the bottom. Just as you can't call the top; valuations looked a bit high in January but sentiment was positive, no one knew Covid-19 was the problem it would become and the catalyst for such a volatile market reaction. I don't know what the catalyst for the recovery will be but then it's never been obvious in the past.
Neil Birrell is chief investment officer and manager of the Premier Diversified fund range at Premier Miton Investors
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