Reality check

Posted by: Paul Donovan

02 Mar 2020
  • The US S&P500 equity index is near a five-month low. Such a loss has only happened 453 times before (end-month data). If markets are pricing an economic recession, this seems excessive. Governments matter, and will offer support. Markets underestimate the ability of people to adapt. Even policies like school closures may be economic positives.
  • Fear remains the focus. Politics may be a problem; the virus is dramatic, but not dramatic enough to cause national unity. Political drama may cause fear to rise. However, Italian opinion polls suggest that people are reacting with irritation as much as fear to the Italian outbreak. Irritation may be helpful - it suggests people take precautions but do not panic.
  • Sentiment is not the same as fear. Sentiment exaggerates underlying trends, and is influenced by the media cycle more than reality in such situations. We saw exactly this pattern with the trade conflict. Business sentiment opinion polls are due today.
  • Central banks cannot cure the virus. They cannot force people to spend. However, central banks can help companies with cash-flow problems, or whose debt service costs are challenging if demand weakens. Central banks exist to solve liquidity and credit problems, should those arise.

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