The uniquely arrogant Masters of the Universe who dominate the financial sector have long assumed that markets themselves would provide the source of the next big crisis.
For years, investors and analysts pored over the intricacies of financial markets, hunting for canaries in coal mines, particularly when the ageing (and now expired) bull run in stock markets started to smell past its sell-by date.
Arcane corners of financial plumbing, from volatility indices to specialist short-term lending markets, have been endlessly scrutinised for signs that they could prove to be the butterfly’s wing that sets off the next big drama in the real economy. Everyone was looking for the modern equivalent of the drop in the Thai baht that sparked the 1998 collapse of hedge fund LTCM, which in turn forced a US Federal Reserve bailout to rescue markets from calamity.
Instead, investors are being humbled by one thing they clearly had not considered: real life. That makes the crisis sparked by the coronavirus pandemic more dangerous, and harder to fix, than anything else previously seen by the men and women currently on finance’s front lines. It will not be the last.
First, some numbers. How bad is this? The global decline in stock market valuations between January 20 and Thursday topped $13tn. That is roughly equal to just over $3bn for each coronavirus death, Nicholas Smith at CLSA, said in a note on Thursday. That is a brutal calculation but we live in brutal times; coronavirus is not just the flu and this pullback is not just a correction.
Just a month ago, the market mood was dominated by lolling complacency and a belief that the virus would be a temporary setback, confined to China. The shift in perspective since then has been staggering.
Thursday saw the direst moment so far, with European stocks dropping farther in one day than they ever did during the eurozone debt crisis of 2011-2012, while the FTSE 100 sank at its fastest pace since the Black Monday crash of 1987. The S&P 500 dropped 9.5 per cent. That means it slumped 20 per cent into a bear market at its fastest-ever pace, more rapid even than in the legendary 1929 crash.
“We have gone from feeling like this is just an equity market correction, which happens, to the point where markets are breaking down. The stuff you see on the screen, the prices, are not accurate,” said David Riley, of BlueBay Asset Management.
The chaos came despite efforts to prop up confidence by the Fed, Bank of England and the European Central Bank. Stocks jumped on Friday, but it is not clear that policymakers have stopped the bleeding.
The equity price falls are striking. But investors are even more unnerved by the fact that the plumbing behind markets started to creak this week. In particular, the most important market in the world — US government bonds — appeared to be short-circuiting. Every experienced trader will tell you that Treasuries “should” be rallying while stock markets slide, providing a hedge to those who want one. But they are not, in part because of banks’ unwillingness to act as go-betweens.
“To me, it feels worse than 2008, more like the LTCM crisis,” one hedge fund manager said. The “total lack of liquidity in so-called liquid products” means some funds will probably not survive this crisis, he added. That, plus the stress in US high-yield bonds, could topple more dominoes. If funds fail, they will have to sell more assets. If companies fail, banks and funds will be on the hook. Markets would be forced to keep pricing in more and more pain.
Already, panic is feeding off itself. “The market has been jolted to the point of breaking, and textbook common sense seems to no longer apply,” Nomura’s Masanari Takada wrote. “Given the extreme uncertainty over what will happen, investors’ own insecurities could cause a worst-case black swan scenario to actually unfold.”
One lesson of previous crises is not to be fooled by fleeting recoveries. Although the S&P 500 dropped by 42 per cent from the summer of 2008 to the autumn, it had cranked 24 per cent higher by the start of 2009. But those who bet that was the end of the drama were wrong; the index fell another 28 per cent before embarking on its long rally.
Should investors have seen this coming? Probably. In late January, the World Health Organization warned the “whole world” to be “on alert” to fight the illness that had taken hold in locked-down Wuhan and started to spread beyond China. Investors took weeks to start listening properly to the scratchy signals coming from somewhere off their patch.
Market professionals must drag their noses out of their spreadsheets and listen to a broader spectrum of voices. Otherwise, the coronavirus crisis, likely still in its early stages, could be just a dress rehearsal for the climate crash.