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The Stock Market Crash Was Inevitable, but Stimulus Will Fuel Another Bull Run

Written by: Richard Harris | SCMP 

Coronavirus has only hastened the inevitable stock market crash, but expect another bull run on the back of stimulus measures

- It was obvious from the initial Wuhan lockdown that the damage to the Chinese economy would reverberate globally. Wall Street’s reaction is not surprising

- Policymakers keen to avoid a credit crunch are pouring liquidity into the market, which will once again fuel an asset bubble

One aspect of the current crisis that has remained largely unnoticed is the orderly way equity markets have collapsed. Market systems have worked without a glitch to discover accurate asset prices to enable investors and policymakers to overreact in the short term to relatively normal long-term volatility.The public has certainly overreacted, becoming the target of ridicule by grabbing all the toilet rolls from supermarket shelves, for example.

In their book Animal Spirits, George Akerlof and Robert Shiller note that the US stock market index rose over five times in real terms from 1920 to the 1929 Wall Street crash, then fell a massive 86 per cent, giving it all back by 1932. It doubled between 1954 and January 1973 – then lost half its real value by October 1974.

It then rose eight times in real terms between 1982 and 2000, disregarding the record 1987 crash, the Asian financial crisis and the bursting of the dotcom bubble. From the 2007 peak to the 2009 trough, it fell 56 per cent. The bulls then drove the index up fourfold to its all-time high just a month ago, leaving the bears to edge the S&P 500 index underfoot with a wimpy 30 percent fall (exactly 1,000 points) to its low to date.

This column, and many others, predicted that the market was ripe for a sell-off after last year’s 29 per cent rise. The once-in-a-decade fall triggered by the coronavirus was merely an excuse – it would have happened anyway, even if it has gone down about as well as a pangolin at a wedding banquet.

And what an excuse. It was obvious from the initial lockdown of the Chinese city of Wuhan that the damaged Chinese economy would threaten a fragile global economy through the supply chain. The Main Street economy is cyclical. It depends on supply and demand; it overshoots and undershoots, surprises and disappoints.

It is subject to cyclical disruption as we see a catastrophic destruction of jobs in one part of the economy, while others prosper. Surpluses and deficits of commodities and sought-after components cause booms and busts. The oil crisis of 1973 roiled inflation for a decade.

The fortunes of Wall Street broadly follow the Main Street economic cycle. A strong economy generates a rise in company earnings – from which stock markets are valued.

Rational analysts conclude that the market is “cheap”, when in fact sticky prices, rent increases and low stock-price volatility merely reflect the virtuous cycle of the economic boom. Markets are collapsing today because that self-reinforcing mirror has been smashed.

As the two streets weaken, a vicious asset spiral makes it harder to pay off debts, leaving the banks holding the baby. Lenders want their money back. A shortage of liquidity then causes a surplus of insolvency. In the past week, money rushing out of shares is going into cash to pay off debt, not into bonds and gold.

At their different stages in the coronavirus crisis, all policymakers have panicked. The US Federal Reserve proved that insanity is to do the same thing twice and expect a different result, by slashing interest rates to zero – and spooked the markets for the second time in 10 days.

Policymakers, however, have quickly twigged that a credit crunch must be avoided at all costs. Hong Kong stands as an example because February’s budget had to tackle an early recession resulting from last year’s riots and the virus epicentre being just 1,000km away. We also have the money to give away – most other countries will just print it.

Employers need short-term loan guarantees to protect wages and jobs, banks need government guarantees to continue lending to small companies, and critical utilities (such as airlines) must be sheltered to prevent their loss to the recovering economy.

Every major country now has a policy of helicoptering liquidity to those most likely to spend it quickly, such as small companies and lower-income recipients, finally recognising that there is no point giving tax breaks to the unemployed.

Many of these guarantees will be called and never paid off – governments are not good at collecting because politicians worry about their future today, and ours tomorrow. Moral hazard is ignored; the indebted become rich again.

Much of that funny money is likely to end up in fake asset prices, so we should expect another bull market encouraged by the protection of the “government put”. The bill will still have to be paid and I have no confidence that it will.

There will be no “V-shaped” recovery. The global shutdown will change companies, economies, careers, relationships and lives forever. There were three waves of the Spanish flu in 1918 and 1919, killing more each time, yet the policy of containment is crippling the global economy to the tune of perhaps US$5 trillion.

This is an enormous cost to battle a virus with a mortality rate of a mere 1.4 per cent of infections. Expect the policy to be in place until midyear – but, after that, tough decisions will be made.

Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, banker, writer and broadcaster, and financial expert witness

Related: What Markets Are Telling Us Now