Virus fears vs central bank support: which will win?

Date: March 23, 2020

  • STI dropped 224 points or 8.5% over the week to 2,410.74;
  • Central banks will try to prop up economies, markets with stimulus;
  • US Fed cut interest rates to almost zero;
  • US government to issue US$1 trillion package;
  • Goldman Sachs forecasted US economy to contract 24% next quarter;
  • Investors sceptical that central banks can cure the virus

Will governments and central banks’ stimulus stabilise markets?

The question on the minds of all stock market players last week was whether concerted central bank action can compensate for the economic slowdown caused by the spreading Covid-19 virus.

So far, the answer appears to be maybe, though this answer is shrouded with plenty of doubt.  One reason for saying this is that as soon as the US Federal Reserve cut its short-term rates by 100 basis points last weekend, Wall Street promptly suffered a massive blowout on Monday last week, with the major indices crashing 12%.

It rebounded sharply on Tuesday after the US government announced a stimulus package of up to US$1 trillion but this was likely more due to short-covering than anything else. As it turned out, the US market continued to dive in the following days, and it remains to be seen how effective this plan could be.

Also on Monday, the Straits Times Index plunged 138 points to its lowest in 11 years at 2,495.77 ahead of Wall Street’s crash. Trading was volatile for the rest of the week – on Wednesday for example, the index first added 60 points – most likely thanks to short-covering – but eventually ended the day with a net loss of 29 points.

Despite the STI bouncing 99.74 points or 4.3% on Friday, it still recorded a net loss of 224 points or 8.5% at 2,410.74. Turnover has picked up of late, with daily averages close to $2b, twice the amount done under normal circumstances.

Wall Street’s all-time highs earlier this year are now a distant memory

Two of the five steepest US market drops in history have happened in the past week. The Dow’s 2,997-point, or 12.9%, drop on Monday last week ranks second worst in the index’s history, only behind 1987’s Black Monday crash, when the index dropped 22.6%.

In third and fourth place are Oct. 28 and Oct. 29, 1929—the worst two days of the Great Crash of 1929. In fifth is the 9.99% crash on Thursday, 12 March.

The collapse on Wall St comes a few months after stocks there rose to several all-time highs earlier in the year after the US and China signed a truce to their trade war.

Wither the US economy?

US Treasury Secretary Steve Mnuchin told GOP senators on Tuesday that if the stimulus was not approved, unemployment could rise to 20%.

Goldman Sachs is now projecting a massive U.S. economic contraction in the second quarter of the year.

The bank is forecasting a 24% decline in economic activity next quarter, compared to their previous forecast for a 5% decline because U.S. economic data (specifically manufacturing data) have already started to miss economist estimates, even before Americans started to stay home to avoid spreading the coronavirus.

Their estimate published on Friday is one of the most pessimistic on Wall Street. JP Morgan released estimates on Wednesday that predicted a 14% contraction in second-quarter U.S. growth.

Central banks can’t cure the virus

Analysts say one reason to doubt the effectiveness of central bank action as compared to the US sub-prime crisis 12 years ago is that economic activity is contracting not because of tight monetary conditions but because of fear.

The Fed’s monetary actions, however, have minimal impact on this contraction in economic activity. At most, observers believe its actions to ease financial conditions could prevent the disruptions in the Treasury market and the corporate credit market from worsening and exacerbating the inevitable downturn in the economy.

By slashing its federal funds target rate back to the low of 0-0.25% reached after the US sub-prime crisis 12 years ago, and not waiting until its regularly scheduled two-day meeting of the Federal Open Market Committee, the central bank apparently sees a cliff-like falloff in economic activity under way.

S-reits could benefit: Maybank Kim Eng

In a 17 Mar Sector Update, Maybank Kim Eng noted that S-REITs have retreated 24% since Feb as the market fell to a 10-year low early last week, but noted that distributions per unit or DPUs could see a lift from the surprise US interest rate cuts.

Sector valuations are meanwhile elevated relative to historical div. yields and P/NAVs following their strong yield compression, accretive acquisitions and index inclusion’’ said the broker.

Current share prices imply most large cap S-REITs are 11-31% below their +1-standard deviation yields and 41-75% above their trough P/NAVs (price/net asset values). We remain selective given the challenging macro outlook, and continue to prefer industrial REITs…’’