Unprecedented Market Volatility

March 26, 2020

Source: Bloomberg Source: Bloomberg

Last Saturday morning, I stopped by the King of Prussia Mall, one of the nation’s largest and busiest shopping centers, and witnessed something I have never seen before. The mall was completely empty after Pennsylvania Governor Tom Wolf asked nonessential businesses to close to help slow the spread of COVID-19, while all stores were closed except for a few restaurants open for takeout only.

This brief trip helped me to comprehend the fastest drawdown of the S&P 500 Index (S&P 500) in history. As of March 23, it took only 23 trading days to melt away 34% of the S&P 500’s value. In 12 of those days, the S&P 500 swung more than 4% in either direction. By comparison, the largest one-day movement of the S&P 500 in all of 2019 was 3.4%. As demonstrated in this week’s chart, the CBOE Volatility Index (VIX Index), a popular measure of equity market volatility expectations, reached a historical high, surpassing the previous record from the 2008 financial crisis.

Equity market sell-offs are largely due to uncertainties and pessimistic forecasts. However, this drawdown occurred because of the spread of COVID-19. The pandemic is affecting the highly integrated global economy in an unprecedented way. We cannot consult examples from history and no one can predict exactly what will happen. While we grapple with COVID-19’s devastating impact on global populations, the question facing markets is whether the pandemic will lead to another financial crisis.

When revenue dwindles as a result of people staying at home, companies still have to pay salaries, bills and interest on their debts. The first liquid source they can tap into is their cash reserve. However, unlike Apple, not all companies have adequate cash reserves. The next thing they can do to raise cash is to sell assets. After that, they look to borrow in the public credit market. The problem currently is that willing lenders are scarce and the cost of borrowing is high. Some companies are able to draw down their credit lines from banks. However, again, not all companies, particularly small and midsize businesses, have enough of these liquidity facilities.

In order to address such liquidity issues, the Federal Reserve (Fed) has announced policies to either lower the cost of borrowing or increase liquidity and encourage banks to make loans. Also, government fiscal stimulus will soon be carried out to help individuals and companies under stress.

In the short term, I will also be paying attention to the strength of the U.S. dollar. Usually, when the Fed cuts interest rates, the dollar depreciates against other currencies. Last week, it had a big rally that could reflect a shortage of dollar liquidity outside of the U.S.

Despite the emptiness at the mall, plenty was happening outside last weekend. In the afternoon, I went for a jog on the Chester Valley Trail. Unsurprisingly, I found more people on the trail than in the mall. As we continue to see more places close and the markets change, it’s important to remember that we are in this together and there is a light at the end of the tunnel.

Key Takeaway

The U.S. equity market is experiencing one of the worst drawdowns in history. The VIX Index has spiked to a historical high and the velocity of the sell-off is unprecedented. In an effort to combat some of the uncertainties we are facing, the Fed as well as our elected government officials are increasing efforts to help individuals and companies.

Tags: Coronavirus | Federal Reserve | S&P 500 | Equity market | VIX Index

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