When panic selling is over, stocks could benefit more than bonds

The panic buying of essential items around the globe – from food to, fittingly, toilet paper – sparked by the spread of the COVID-19 coronavirus has been mirrored by panic selling in capital markets. It’s almost as if investors were taking cash out of stocks and bonds to buy whatever food, hand sanitiser and toilet paper they could get their hands on.

Pessimism in global financial markets has reached heights not seen since the dark days of the great financial crisis of 2007-2009, which this current crisis threatens to overtake in depth and significance. But, as news about rapid tests for COVID-19 and resilience to deal with the virus begin to multiply, could investors hope for a bottom in the capital markets’ selloff?

Some famous investors – such as Pershing Square’s Bill Ackman — say so, while some market sentiment indicators are giving off intriguing signals.

But many investors worry that companies that have seen demand for their services and products evaporate because of the restrictions imposed by governments to fight the virus will go bankrupt. It is hard to find the present value of future cash flows for businesses whose earnings are disappearing overnight.

Perhaps this is why the Bull & Bear indicator, developed by Bank of America researchers as a gauge of market sentiment, dropped to its most bearish level possible – zero.

Bull Bear Indicator

The Bull & Bear indicator shows extreme bearishness. Source: Bank of America global research

Year to date (as of March 26), commodities tanked by almost 37%, global stocks lost 24%, and high-yield bonds (also known as junk-rated bonds) lost 18.5%. Even the once-sacred investment grade bonds have fallen 9%.

The only fixed income assets still in the green are government bonds, hanging on to positive territory with a meagre 0.5% return year to date. Gold, the usual safe haven of choice, is up 7.2% while world’s reserve currency (the US dollar) is up 4.8%.

Is the selloff overdone? Is Ackman right and we have seen the market bottom? While it is foolish to attempt to time the market, investors seem to have overlooked an awful lot of green shoots.

Reasons for optimism

In the healthcare field, there is encouraging news about the race to develop faster tests. These would allow on one hand quick diagnosis and isolation/treatment, and on the other hand the reopening, even if partial, of some sectors of the economy.

A recent Deutsche Bank research report lists three such tests. The first is developed by US medical device maker Henry Schein — a pinprick blood test that delivers results in 15 minutes (versus the current two days wait time for results).

A UK company, Mologic, has sent prototypes for a 10-minute coronavirus test to labs for validation, and Germany’s Robert Bosch has developed a test that can give results in less than two and a half hours.

The German company’s test is seeking the actual virus, rather than the antibodies, so it can find people who are currently infected. The other two find the antibodies – meaning that people who had the infection and have recovered could potentially return to work.

The other major positive news that is being ignored for the moment is the huge stimulus that has taken place at a monetary and, most importantly, fiscal level. The old austerity rulebook has been torn apart virtually everywhere, as governments suddenly find the “magic money tree” to deal with the crisis.

In fact, so much stimulus has been thrown at the markets and economy that inflation may finally show up, even though it doesn’t seem so today as oil prices have plunged.

This could turn investors’ preferences from bonds — which had been supported by central banks pushing interest rates lower and lower — to stocks. But this is a scenario for the medium term. For the short term, watch to see if the panic is indeed over – both in supermarkets and in stock markets.