Anatomy of a Crash: The Coronavirus Recession

Anatomy of a Crash: The Coronavirus Recession

What can we learn from the past as we approach the Coronavirus Recession?

Alexander El Alaoui

Apr 22, 2020



min read

Recession chat is everywhere, but 12 months ago a global economic downturn seemed a very distant possibility to most of us.

And the thought of a recession due to a coronavirus pandemic? No one had that on the radar for 2020.  

March 9th 2019 marked the 10-year anniversary of the longest bull market in history, with stocks constantly rising for 120 months, versus a mere 113 months in the 1990s.

And for a long time it seemed like there would be no end to it: in late October 2019, the S&P 500 Index cracked the magic 3,000 mark and only four months later, in February 2020, its closing price was over 3,800.

But March 9th this year told a very different story. It would have been the bull run’s 11-year anniversary, but instead the S&P dipped and settled at 2,746.56. Markets were already in free fall, after the COVID-19 virus had started infecting hundreds of thousands of people across the globe, and with it, the global economy. Recession 2020 was suddenly a possibility, and the Great Lockdown was on its way.

A recession like no other?  

Canny investors knew this day would come eventually. The general feel amongst seasoned finance experts was that markets were hopelessly overvalued, thanks to massive amounts of cheap central bank money fuelling corporate borrowing. Plus, the Trump Tax reform of 2017 (which slashed corporate tax by 14% and repealed the legislation designed to make sure companies paid at least some tax, amongst other business-friendly measures) had led to mountains of cash piling up, which companies were using to purchase their own shares, giving their valuations an attractive facelift.

It’s just surprising that a virus that no one had heard of would bring about an end to this second-to-none type of a boom, leading to a global recession. Not the unravelling U.S-China trade war. Not rising populism and nationalism. Not even Brexit.

A virus.

Some commentators agree that the crash we are now witnessing is unlike anything we have seen before, while others argue that the economy had just reached the final stage of a 10 year cycle, following its “natural” course.

As Sallie Krawcheck, a former Wall Street executive, pointed out: "Every financial downturn is different, and every financial downturn is the same".

So are we in uncharted territory or is this just another downturn that can be navigated through looking at past global recessions? Can we tell if this is a recession or depression? Should we buckle up for a few months of uncertainty, or is this going to take years to recover from?  

Let’s look at the similarities and differences of past recessions for clues.

Coronavirus recession is different because... of the speed  

The last crash in most people’s memory is the 2008 collapse of the U.S. housing bubble, an economic decline that unfolded remarkably slowly: more than 12 months passed between the early signs of a recession and the actual event.

Fast forward to today and you see none of that gradual decline: governments and central banks around the globe are taking swift and totally unprecedented action to deliver on their promise to do “whatever it takes”.  

And why is this necessary?

The VIX index, used to chart the volatility of the market (often referred to as the investor fear-gauge), climbed to its all-time high on 16th March. Investors across the globe sold their assets out of fear: stocks, bonds, even gold was traded for cash, which meant central banks had no choice but to step in.

16th March VIX index

Enter “bazooka” money – outlandish stimulus packages, emergency interest-rate cuts, massive bond buying programs, trading suspension — all because stock markets responded with dizzying volatility to the growing uncertainty around the coronavirus pandemic.

Coronavirus recession is different because… Joe Public is getting bailout money

Unlike most other global financial events, COVID-19 has infected both Wall Street and Main Street. Whereas in 2008, less extreme measures were taken to help Wall Street recover, the radical steps taken today are aimed at getting Main Street back on its feet again.

With governments introducing stay-at-home orders, companies have been forced to cease production and lay off workers, which has led to both a collapse in the supply and demand of goods. Policy makers around the world have been quick off the mark to try to cushion the blow of this. This has not been another Lehman crash — coronavirus has hit the ordinary Joe and Jane.

While banks are struggling, it’s obvious even at this relatively early stage that small bricks and mortar businesses are the ones that are going to find it almost impossible to navigate the next few months and come out the other side with their business intact.

That explains why countries such as the U.S. have even gone as far as to announce “helicopter money”, a last-resort type of expansionary fiscal policy where vast amounts of cash are directly distributed to the public to get the economy moving again. This “COVID-19 fiscal blitz”, as Alexander Chartres, Investment Director at UK investment firm Ruffers puts it, makes this crash stand out in history.

Coronavirus recession is different because… the event is unpredictable  

While the 2008 housing bubble  was, for the most part, “manmade” – you could see it coming if you wanted to – the spread of COVID-19 is an exogenous shock, originating externally and beyond the control of market participants.

Economist Nassim Taleb has coined these events “black swans”: they appear rarely and unexpectedly, but when they do, you will notice them.

It’s a romantic notion for something that has such a devastating effect.

The problem here is that the mere existence of a black swan debunks the widely-held belief in asset management that most financial risks can be computed — and therefore forecasted — along a Gaussian bell curve. This means volatility is dangerously underestimated.  

Analysts are ill-equipped to grasp, let alone properly assess the magnitude, timing and likelihood, of an unlikely-but-not-impossible event such as a global pandemic.

Coronavirus recession is different because…the results are unpredictable

Similarly, economists have a hard time estimating the true extent of this shock while it unfolds in real-time. For example, the loss in U.S. GDP in the second quarter of 2020 is projected to be somewhere between 0.4% (Federal Reserve of New York) and 35% (JP Morgan Chase), which is an enormous range.

France predicts its economy will shrink by 8% this year, while in the UK the GDP may go down by 6.5%.

According to the IMF, the world may face the worst recession since the Great Depression of 1929.

Economists are in the dark, trying to navigate unknown terrain. In other words, things look bad, but there is disagreement as to how bad.

Coronavirus recession is the same because… markets will (and are) rising

All of the above is different when compared with the 2008 crash - but what’s the same? Well, the only thing that most agree on is the fact that markets will go up again eventually, it’s just not clear when it will happen and what recovery from a recession will look like.

In fact, finance experts have had a hard time understanding what recent upward ticks mean. Are these courtesy of opportunistic cheap shoppers causing short-lived bear market rallies, a phenomenon frequently observed during long-lasting market plunges? Is a full meltdown yet to come or have we already hit rock bottom?

Just as importantly, when the markets do finally go up, what shape will that take? Will it be a simple V shape, with a sharp drop matched by a sharp rise in stock value? A U, with the down followed by a period of inactivity before a sharp rise up again? Or perhaps a Nike swoosh, characterised by a slow and steady rise? This is something only the benefit of hindsight will tell us.

Coronavirus recession recovery

Coronavirus recession is the same because… some companies are benefiting

Some investors have already started making cautious bets with tactical buys (while remaining prepared for things to go south again). There’s been a lot of publicity around the companies that stand to benefit from global lockdown, such as those that help people work remotely, including video conferencing and chat platforms.

But many companies are facing long-term doubt over their future. According to Jim Neumann, CIO at Sussex Partners “some areas are too damaged or too uncertain for investment in the medium-term”, including energy stocks and the travel industry.

Coronavirus recession is the same because… ESG performance is steady

Funds labeled “sustainable” are traditionally less exposed to these sectors - so, does that mean greener investment strategies have an edge over conventional products?

On March 31st this year, 59% of U.S. ESG funds were doing better than the S&P 500 Index, while 60% of European ESG funds beat the MSCI Europe Index. According to a Bloomberg analysis, so-called ESG funds tend to outperform their peers during this crisis.  The reason for this is simple: if you don’t own an airline, you’re not hit by the travel ban, if you’re not exposed to an automaker, the weak car sales won’t matter much to you, and if you’re not invested in a fossil fuel company, the oil price crash doesn’t affect you.

As the saying goes: “What you don’t own in a portfolio can be more helpful than what you own” - in other words, your first job is to make sure you’re not exposed to any risk, while the second is to take advantage of good opportunities.  

So what can we learn from past recessions?

While the event we’re currently experiencing is unprecedented, it’s clear that the market is behaving in ways that it has before. It’s difficult to assign lessons while we’re in the eye of the storm, but certain things are becoming obvious.

- Investors need to reevaluate their understanding of risk — it comes more often than financial models allow for or understand.

- Investment should be made with a view to the long-term, and without too much focus on short-term performance metrics.

- Good investments no longer come from inflated profit margins, but from a solid business model and resilience during a crisis.

These lessons are especially important, as we are potentially embarking on a new dawn with black swan events (or ‘tail risk’) occurring with increasing frequency.

Today it’s coronavirus, but tomorrow, these events are likely to be related to climate change.

As Mohamed El-Erian, chief economic adviser to Allianz and former Pimco chief executive, says: “A very big tail risk is climate change. If ever there was a global shock or disruption that knows no boundaries, this is it. But the level of co-operation has been disappointingly low. I hope people will realise tail risk is something that has to be taken seriously.”

Perhaps the only lesson we can take is that it’s time to prepare for the unexpected.

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