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Financial markets suffering a shock – but not a financial crisis

16 Mar. 2020

By: Jeppe Christiansen, CEO

The global financial markets have been hit by a “coronavirus shock”. When you think about how many professionals in the fields of medicine and disease have, for so many years, warned us about viral epidemics, you can wonder why investors (and politicians) haven’t been better prepared. On the other hand, I’ll be the first to admit that I, too, have also been surprised by the strength and speed of this coronavirus crisis.

But this is not a financial crisis. It is what is known amongst economists as an economic crisis, prompted by a so-called exogenous shock. Looking back over the past 50 years, we can find two similar examples. One was the 1973 oil crisis, when the oil price quadrupled in a short space of time and Denmark implemented car-free Sundays. Back then, the country was also in turmoil and the stock market came tumbling down. It was believed then that inflation and unemployment were the new phenomena that we would have to contend with forever. The other example was the 9/11 attack on the Twin Towers in New York. Again, the world was in tumult. The New York stock exchange was closed for several days and the west was “at war” with Islamic terrorists, who we thought would change the world forever.

My immediate thoughts are that the world hasn’t changed. Over the centuries, we have seen many serious conflicts across the world, and we have always had viral epidemics. There’s nothing new under the sun. What is new is the way in which information about an epidemic can spread. We have media coverage like never before, and breaking news leads to what Swedish professor Hans Rosling described in his book, Factfulness, as an extreme belief that the picture the media creates is the same as the actual underlying facts. In his book, he proved without a doubt that this isn’t true.

This article will review the facts of the coronavirus crisis, the facts likely being the decisive factor in how the situation unfolds. The turmoil will abate, and the world won’t be forever changed, but it will be violently affected by a so-called exogenous economic battering that will hit the global economy hard and then gradually weaken until it finally disappears.

The financial markets have already reacted fiercely to the coronavirus. First came the realisation that the epidemic in Wuhan would impact China and rip into the global production cycle. Of the world’s industrial products, as much as half is manufactured globally, and Chinese factories are a gear in that system. In January came the understanding that China’s factory closures could tear a chunk out of global economic growth but that we would quickly recover. But then when it became clear that the virus will spread across the globe in one form or another and that the authorities will need to intervene with travel restrictions, quarantines, bans on large events, and, ultimately, a lockdown of countries (Italy) or the imposing of a state of emergency (California), a change occurred.

This has set in motion investor fears of a global economic recession, immediately impacting stock exchanges around the world. Figure 1 shows how much this has affected price development. Hardest hit have been airlines, oil, and tourism. But the major equity markets have also lost around 25% in value. Interest rates in the USA have fallen by more than 1% and the gold price has risen by 3%. Amidst the upheaval and falling prices, the oil market collapsed because the large oil-producing countries could not resolve which amongst them was going to cut production; meanwhile, demand for oil was falling. Oil price cartel OPEC is in a tight spot and cannot reach a co-operation with Russia. In reality, this is positive news, because price cartels destroy the competition that creates global economic growth. In the short term, however, this drop in oil prices is negative since it has come in an unexpected manner. The shor-term effect is that the oil-producing countries become poorer and purchase less, while many oil companies suffer problems with indebtedness.


The coronavirus is, per se, milder than many other of the world’s serious diseases. The problem is its rapid spread, putting healthcare systems under such pressure that – if not handled wisely – it can unleash panic in many societies. The speed at which the virus spreads must be hindered as much as possible, and so we are seeing travel restrictions, cancellations of events, and quarantine, among other actions.

Figure 2 illustrates the mortality of different virus outbreaks. Common seasonal flu normally results in around 650,000 deaths a year on a global basis (according to Denmark’s Statens Serum Institut). With about 5,000 deaths as of 13 March, the coronavirus epidemic is hardly of the magnitude of the top 10 deadly diseases in the world when assessing the currently available data. However, what is of great importance right now is where it spreads and its consequent effect on both production and demand.

Coronavirus has an enormous – short-term – impact on the global production of industrial goods. Almost all essential industries are being affected by production chain delivery issues stemming from some form of dependence on Chinese deliveries. The best indication of the extent of the problem comes from assessing the business sector’s PMI index, which indicates industrial activity worldwide. Note that figure 3 shows China at an index reading of 36 and the large western economies at 46, while emerging markets countries are at 40. Typically, an index reading of less than 50 implies negative growth. At the same time, demand is hurt by the many restrictions on travel, events, transportation, and traffic, and not least by consumer fear, which leads to caution and prompts many to curb their consumption.

We will very likely experience a “technical recession” across large swathes of the world. This is defined as two consecutive quarters exhibiting negative growth. We also cannot rule out an actual global recession of a somewhat longer duration.

The extent to which global industrial production has already been hit is difficult to judge precisely. China will probably have experienced negative growth in the first quarter, perhaps of -5%. It typically sees positive growth of 6% in this quarter. There is a risk that this extends into the second quarter and impacts both Europe and the USA, much like the Italian coronavirus situation is currently hammering the heavy machinery industry in northern Italy. Overall, this alone can hurt global growth rates by 1% or more.

But China is on the up again. Figure 4 shows a rebound towards full capacity utilisation in the country. The factories are once again at capacity utilisation of around 90%. Global supplies of industrial goods – including cars, computers, and mobile phones – will gradually return to normal.

This suggests that global production will return to normal in the second quarter, or the third at the latest. But before that, the whole demand economy is in imbalance. Demand will be affected by airports closing, events being cancelled, and employees being sent home to isolate themselves. At the same time, consumer behaviour will change for a while. When people fear a crisis, they automatically consume less and typically also defer investments. This leads to lower growth and, consequently, reduced income. This, in turn, puts a damper on consumption, and it can trigger layoffs by many companies. This is referred to as the multiplier effect.

Based on this, some economists and analysts conclude that we are, in all likelihood, headed for a long-lasting global recession that will impact all financial markets and will be amplified by the negative effects of the large debt levels across the globe. The debt problem will have a direct effect on the banking system, and many are thus concerned about a new financial crisis – which is why bank shares have been hit hard.

This picture is far from accurate. We have a well-regulated banking system today. The banks have large capital reserves and considerable liquidity. We have central banks that have become practised since the financial crisis at dispensing monetary policy efforts correctly. But with interest rates at 0%, nothing more can be done along these lines. However, many countries have the possibility to introduce major fiscal measures, financed with bond issues. The central banks can then buy these via what the finance industry calls QE programmes.

It is Maj Invest’s assessment that we will experience an economic recession rather than a financial crisis, and that we will subsequently see a return to the previous growth trajectory, with global growth rates of 2-3% - a little lower than previously expected.

In other words, one should view this coronavirus crisis as an external shock that slows down growth for two quarters or more, after which the global economy bounces back to close to its old patterns, the difference perhaps being that growth is a little more muted thereafter.

In 1973, when the oil crisis hit, the stock markets fell 10-40%. The world wasn’t as global back then, and that meant Europe was harder hit (having no oil of its own) than the USA, which had considerable oil production. In 2001, at the time of 9/11, the equity markets’ fall of 10% was immediate, but the global recession that kicked in shortly after was because of over-investment during the period up to 2000 (the dotcom era), among other things.

The big question is: what does a crisis “cost”?

How much will growth decline by? And how large a tumble will the stock markets take?

We can, with some certainty, expect a global growth crisis lasting for around a year. Experience tells us that will trigger a stock market crisis.

Figure 5 shows how much a stock market crisis typically “costs”. As can be seen, it depends on the economic background to the crisis. The “cost” of a normal recession is a drop of some 25% in stock prices, while a financial crisis “costs” up to a 50% fall.

On analysing the crises in 1973 and 2001, we can see that the stock markets fell by around 30-40%. We can compare that with the drop of some 25% in the current coronavirus crisis. In other words, we are two-thirds of the way towards that. We still lack insight into how the coronavirus will affect the USA, and it could be 4-5 weeks until we see this.

A good estimate could be that the stock markets are at risk of falling further. But remember that the fundamental value in companies remains substantial. Right now, stocks are trading at values equivalent to 10-20 years’ earnings. This means that a coronavirus crisis (estimated to eliminate one year’s earnings) would imply a drop of 5-10% in companies’ fundamental values. In other words, stocks shouldn’t fall more than 5-10% on account of the coronavirus if we believe that the global economy can get back on track after a year. But it is well-acknowledged that stock market reactions over longer periods can be far greater.

In this context, it’s worth stating that the Spanish flu (the viral epidemic that spread in 1918) unfolded across Europe in three waves, lasting a total of 8-10 months. Perhaps we should expect some of the same patterns with the coronavirus and therefore not exclude a spate of outbreaks in the USA in the spring and then a further wave in the autumn. In such a scenario, the coronavirus would last for up to a year – just like the Spanish flu. But if the global economy does return to its old patterns in 2021, or perhaps 2022 in the worst case, companies’ fundamental values will hardly fall by more than 10%, or 20% at the most.

Most of all, one should remember that shares are one of the few forms of investment that offer returns. Interest rates are around 0% across much of the world. A typical stock dividend is about 2-3% - much more attractive than the interest rate on a government bond.

Interest rates were 7% in 1973 and 5% in 2001. In both these crises, investors had many good (in fact, better) alternatives to equities. It was therefore logical that we saw large exits from the stock markets back then. This is not the case today. For the long-term investor now, equities are the right place to be. Allocations in government bonds with 0% interest rates are, in reality, manifestations of the fear of an economic recession or the need for liquidity and risk spreading. As a short-term or low-risk investor, one should always have bonds to ensure that these latter two conditions are met. But the long-term investment that offers the most value is – even when acknowledging the impact of the coronavirus – in equities; in the form of stocks in a listed company, a private entity, or perhaps even a startup. Such an investment will certainly see more and larger value fluctuations but also more long-term added value and thus better returns.


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