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GIM Team Addresses The Most Pertinent & Frequently Asked Questions

March 20, 2020

How is the current bear market similar to past selloffs in 1987, 2000 and 2007-2008?

The current environment shows a number of similarities — volatility, credit concerns, a liquidity crunch and market irrationality to past markets— but also exhibits important differences. The recent 27% bear market decline in only 16 trading days from February’s all-time high is the fastest in history, outpacing 1929’s roughly 30-day plunge and 1987’s 37-day decline. (For further information please reference our Market Snapshot from March 15, Past Recoveries Have Followed Past Rapid 25% Pullbacks). A notable similarity with the Great Financial Crisis in 2007-8 are extreme levels in the CBOE Volatility Index (the “VIX”), also known as the “fear index,” which hit a record high on March 16. The difference today is that banks are well-capitalized and we don’t have structural weakening of the financial system. The record speed of the market’s recent descent reflects investors’ uncertainty over the extent of coronavirus-related economic damage, coupled with fears about personal and family health.

What policy responses would help stabilize the markets? Does the Fed have more tools beyond their recent extraordinary measures?

The Fed has acted forcefully to help maintain liquidity and market efficiency by cutting interest rates to near zero, injecting $700 billion of quantitative easing and providing support for short-term business lending. The Fed has indicated that it has more levers and is prepared to take additional steps as needed. Still, the Fed’s ability to reassure markets in a public health crisis is limited. Overwhelming uncertainty over the potential extent and duration of coronavirus-related economic damage continues to drive market volatility and a liquidity crunch. Although markets responded favorably to the Fed’s liquidity support, fiscal stimulus in the form of massive government spending and other steps likely will be needed to restore investor confidence.

What are the chances that U.S. equity and/or credit markets may shut down temporarily, as occurred following the 9/11 attacks?

Markets are unlikely to close because technology improvements since 9/11 allow trading to continue regardless of its geographic location. The closure of markets following 9/11 was driven by concerns over physical security and telephone outages, rather than the market’s actual decline. While only the Treasury can close the markets, the SEC and Treasury officials have indicated there would be no need to close markets because electronic trading can continue even if segments of the market were closed for extended periods. We do realize both CBOE and New York Stock Exchange have decided to close their trading floors but as previously stated they will continue to trade electronically. Click here to see what the NYSE move to all-electronic trading means for our clients.

What market indicators are you watching most closely to understand what may be coming?

Though there are many, the two indicators we believe to be most important to watch are data related to the spread of the COVID-19 virus and the VIX. In the short term, the most important is data tracking the spread of the COVID-19 virus as markets are unlikely to stabilize before the rate of infection begins to plateau — markets remain volatile because the rate of infection in the U.S. is still increasing. The level of fear in the markets measured by the VIX is a key indicator, as is the inversion of the VIX curve, showing shorter-dated volatility higher than longer-date volatility. Both indicators are currently at extreme levels, suggesting the potential for unprecedented market moves.

What are the fixed income and options markets signaling about equity markets?

At current volatility levels, the options markets are signaling the potential for large market moves to continue. Using the S&P 500 Index as an example, the market’s implied probability of moving up or down by 10% in the next month was greater than 50%, based on 1-month volatility and options prices at the close on March 16, 2020. This compares to an average implied probability of less than 10% for a similar move for the period between 2010 and the market’s all-time high on February 19, 2020. This indicates that compensation for short-term volatility risk is at extreme levels. With extreme volatility causing distortions in fixed-income markets, other important indicators are stabilization in credit spreads and funding markets (including money markets and commercial paper), and improving liquidity in investment-grade and high-yield bond markets.

 

The views expressed represent the opinions of the GIM portfolio managers as of March 20, 2020 and are not intended as a recommendation of any security, sector or product. These opinions may change at any time without notice to you, and are based on existing facts and circumstances. Past performance is not indicative of future performance. Actual performance may vary from any opinion reported herein. Information herein was gathered in good faith from third party sources which are assumed to be reliable, but accuracy is not guaranteed. For institutional adviser use only, not intended to be shared with retail clients.