Market volatility and the COVID-19

March 9 2020, is likely to go down in history as the U.S. stock market experienced its worst day (-7.6%) since December 2008 (Chart 1), bringing it to the edge of bear market territory (-18.9% since its February 18 peak, Chart 2). Adding fuel to fire, oil prices saw their levels fall by ~25% in a single day - the largest such drop since the 1991 Gulf War (Chart 3) - following the breakdown of negotiations between OPEC member countries (+ Russia) prompting Saudi Arabia to engage in a price war And finally, the race into safe havens pushed US 10-year rates to historic new lows (Chart 4), leading to stratospheric gains for longer term Treasury bonds (Chart 5). Quite a day.

Now, what to think of such variations? Simply put, markets are currently traversing a storm in the form of a pandemic, doing their best to push forward - albeit with much reduced visibility on the near-term trajectory of the economy. As such, we should continue to see gusts in all directions - sometimes downwards when bad news accumulates (as we had yesterday, March 9) and sometimes upwards when governments act (as is the case as of this writing, March 10 AM) - as markets continually recalibrate their expectations in light of available information, and not always rationally. Concretely, we should also expect central banks to continue to ease monetary conditions - the Federal Reserve is expected to lower its policy rate a second time next week (Chart 6) - although the effect of such measures will mostly kick in once the Coronavirus is behind us.

When will COVID-19 storm be over? That’s indeed the one question for markets, but none right now can answer it with any degree of certainty. On the bright side, the latest data in this regard show that the contagion in China is largely under control, while growth of new cases in other parts of the world is slowing (Chart 7). However, a closer look shows that some regions - notably the U.S. and Europe are likely to be several days (or weeks) away from seeing their number of cases reach a plateau, assuming that the experience of ex-Hubei China can serve as a reference (Chart 8).

So, what should we do in this context? In the near term, we continue to advise caution - we took risk off the table in January and mid-February and raised levels of cash in our four mandates managed by Nick Majendie - Verus Defensive Income, Verus Dividend Growth, Verus High Income, Verus Infrastructure. The cash levels are as follows: 24% in Verus Defensive Income, 31% in Verus Dividend Growth, 31% in Verus High Income, and 19% in Verus Infrastructure. That doesn’t mean investors should rush into safe havens - they are already discounting a lot of bad news at these levels (Chart 9) - but the environment remains too uncertain and sentiment not sufficiently depressed (Chart 10) to prompt us to add back risk-assets at this point.

From a long-term perspective, it should be noted that the equity risk premium is now at an eight year high, a promising sign for investors whose investment horizon is measured in years rather than months (Chart 11).

National Bank of Canada (NBC) is a public company listed on the Toronto Stock Exchange (TSX NA). The particulars contained herein were obtained from sources which we believe reliable but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. NBC may act as financial advisor, fiscal agent or underwriter for certain of the companies mentioned herein and may receive remuneration for its services. NBC and/or its officers, directors, representatives, associates, may have a position in the securities mentioned herein and may make purchases and/or sales of these securities from time to time in the open market or otherwise.