Recent years have been challenging for market doomsayers, with big equity markets steadily rising and volatility dampened across asset classes. The spread of the coronavirus and understandable fear of its impact has given a boost to professional controversialists.
It didn’t take long for Nouriel Roubini, the economist known as Dr Doom, to warn that the stock market selloff in late February was a signal of much worse to come, as he ranked the coronavirus among the “white swans” of 2020, meaning causes for financial crises that are predictable.
This approach does not always take into account the policy reactions to serious problems, which complicates the real-world task of hedging and positioning for the impact of an epidemic.
Selling of consumer and airline stocks in expectation of weak demand is logical, but so is anticipation of even lower interest rates due to attempts by central banks to cushion the impact of a downturn.
And betting on a boom in safe-haven commodities such as gold and silver in reaction to renewed rate cutting might be problematic. Financial stress is often accompanied by sales of liquid assets to cover collateral calls, which can distort individual markets.
Higher volatility generally boosts trading revenues for banks, at least temporarily.
Signs of strain
On the second day of a 7% downturn in US stocks in late February and a rise in the VIX option index to 27, JPMorgan said at its annual investor day in New York that it anticipated a double digit percentage increase in its first-quarter trading revenues compared with 2019.
But a prolonged period of uncertainty will affect deal-making revenue, and there were already signs of strain in the credit markets, which had been enjoying an unruffled run of steady spreads and strong demand for new issues that put even the recent equity market complacency in context.
A fall in price for pandemic bonds that the World Bank issued in 2017 drew attention.
The debate over how much value these niche bonds contribute to fighting pandemics will continue
That innovative deal marked an attempt to shift pandemic risk from low-income countries to the financial markets via a hybrid of derivatives exposure and capital market issues with relatively high coupons – Libor plus 6.5% for class-A notes that cover exposure to flu and coronavirus, and Libor plus 11.1% for class-B notes that cover coronavirus and additional infectious diseases.
The risk transfer through the bonds and swaps was for a total of $425 million in trades structured by the World Bank’s own treasury, along with reinsurance firms Swiss Re and Munich Re.
The debate over how much value these niche bonds contribute to fighting pandemics will continue, but bigger concerns for the credit markets were signs that the long gravity-defying performance of junk bonds might be coming to an end.
The global equity market downturn in late February coincided with a suspension of new bond issuance across both the investment grade and high-yield markets. It also saw a sharp widening in high-yield bond spreads to Treasury yields.
Fortunately, amid growing debt and equity market concern, there was one man who stood as a beacon of reasoned optimism.
President Donald Trump followed his return from a visit to India with a prime-time evening press conference that tried to convince Americans – and global markets – that there was no reason to overreact to the spread of the coronavirus.
Trump had already tweeted that the stock markets looked “very good” to him after their February fall; his National Economic Council director Larry Kudlow recommended buying equity dips.