Interest rate cuts alone will not be sufficient to curb stock market volatility as long as the number of coronavirus cases continues to increase around the world, market strategists are warning.
Both the U.S. Federal Reserve and the Bank of Canada cut interest rates by 50 basis points this week, moving to cushion the economy from the effects of the virus and revive market confidence.
But the Dow Jones Industrial Average went into selloff mode shortly after the rate cut on Tuesday, before surging back on Wednesday. It is still about eight per cent lower than before the market crash last week.
“The market is understanding that there are limits to these policy tools when it comes to something they can’t control, which is the spread of the virus and its impact on the economy,” said Derek Holt, head of capital markets economics at Scotiabank.
“No one can say with a straight face that they know how this virus will evolve,” he added.
While the Bank of Canada was due to make an interest rate announcement this week, the Fed’s move was an emergency rate cut, only the first since the 2008 financial crisis. Data from Bespoke Investment Group shows that a rate cut between Fed meetings, like this one that took place Tuesday, usually results in a spike of 1.2 per cent in stocks, on average, and a decline of 0.72 per cent the next day.
The opposite seems to have happened this time around.
“There has been a structural type of feeling among investors for the last 11 years that you should buy stocks when interest rates go down. But it’s hard to make that call right now, especially because we are at the mercy of headlines,” said Brian Belski, chief investment strategist at BMO Capital Markets.
“The problem is we remain, from an investment standpoint, excessively reactionary. So what’s going on right now in markets has less to do with the central banks and a lot more to do with this epidemic and fear that is gripping financial markets,” he added.
The Toronto Stock Exchange appeared to be buoyed by the Bank of Canada’s interest rate cut, rising 2.17 per cent over the course of the day. But it is still about seven per cent below its recent highs.
“I would say if you look at the market from the lows of last Friday, there’s somewhat less pessimism after the rate cuts,” said Stefane Marion, chief economist and strategist for National Bank of Canada. “Markets are trading approximately 10 per cent down from recent highs, reflecting the fact that a couple of weeks ago we were expecting earnings per share to be up about 10 per cent globally this year,” he said.
There’s somewhat less pessimism after the rate cuts
Stefane Marion, chief economist and strategist, National Bank of Canada
The disruption the virus has wrought on global supply chains is a key concern for investors and policymakers. Major electronics and tech companies rely on getting parts from South Korea (a semiconductor manufacturing hub) and China, two countries hardest hit by the virus.
Apple and Microsoft had revised their earnings growth forecasts weeks ago, citing potential supply chain issues. On Wednesday, GE Industrial warned that they would likely see a negative impact from the virus to operating profit of about “US$200 million to US$300 million.”
“The stock market is traditionally a forward-looking discounting mechanism. For all intents and purposes, the stock market probably has a good chance of already kind of telling you that there is going to be potential issues with earnings,” said Belski.
National Bank’s Marion, who anticipates there will be yet another rate cut by both the Fed and the Bank of Canada, says that with easing, the central banks are buying the market a few days, or weeks at most, but not months.
“Now it is up to fiscal policy to step in, but the biggest change is how do you provide fiscal stimulus that coaxes corporations to limit layoff activities because of the virus? Because layoffs will be dangerous for equity markets,” he said.
Scotiabank’s Holt is also of the opinion that fiscal stimulus will perhaps give markets more reassurance.
“It’s like going to the doctor,” he said. “You get a bitter pill, and the doctor tells you things will get better eventually, but you can’t get rid of that near-term ailment.”
