Many portfolios were already nursing big losses from big falls seen during the previous two weeks. An oil price war heightens the pressure on energy shares and debt. It also reinforces demand for long-dated government bonds as oil has historically driven inflation expectations.
One only has to look at the 1 percentage point drop in the US 30-year Treasury bond yield — from 1.70 per cent to a low of 0.7 per cent — in just the past three trading days to appreciate the historic nature of the current market turmoil. The scale of such a drop, not seen since the financial crisis, suggests a very pessimistic view of central banks' ability to fight the threat of the global economy sinking into a long-term trend of Japan-like deflation.
Investors also need insurance and a still relatively high US 'long bond' yield provides scope for price appreciation in portfolios suffering a severe hit across their holdings of credit and equities. That may help mitigate forced sales of assets by some investors but only up to a point. Big market shakeouts can escalate over several weeks as risk managers take a hard line and subject portfolios and trading desks to much lighter limits.
There is also the prospect of increased "margin calls" on traders to stump up more collateral on their positions. In turn, this is likely to compel the sale of shares that have performed strongly up to now. A more troubling sign for markets would be that of asset managers 'gating' their funds, preventing investors from selling their holdings.
The market turmoil also reinforces the need for central banks to make sure liquidity flows for small and medium-sized businesses and yes, help contain financial market contagion.
"We expect central banks' actions to focus on liquidity provision and keeping credit flowing through the financial system rather than trying to deliver big rate cuts or new quantitative easing programmes" Paul O'Connor, head of the multi-asset team at Janus Henderson Investors, said.
Many investors will look back over the past decade and note that financial markets have ultimately bounced back from various bouts of turmoil and panic. Buying the dip has worked no matter how tough things have looked at various stages. The scale of today's declines in equity benchmarks is redolent of investors capitulating, a necessary development before markets can stabilise and eventually recover.
And a small crumb of comfort at this stage is that the combination of very low-interest rates and oil prices followed by governments boosting their spending will register in the next few months. The coronavirus will also abate and help nurture a recovery in the global economy.
"The catalysts for a market turn are more likely to be some combination of peak infection rates, underweight positioning and very cheap markets," argues John Normand at JPMorgan.
On those metrics, financial markets face quite a wait before the music resumes playing.
Written by: Michael Mackenzie
© Financial Times
