Boom, Doom, Gloom - The economic cycle in a nutshell

Brexit now seems like a distant memory as there is now a new topic in town and this one makes our withdrawal out of the EU seem like a breeze.

Coronavirus is the global topic of conversation and has taken the world by surprise. While Brexit worries had a big impact on the UK stock market, COVID-19 is making waves in stock markets all around the world.

Before the pandemic emerged, the world was storming away and we saw the stock markets reach record highs. The fundamentals were strong and we saw unemployment levels at record lows. Since the start of the market falls on 20 February, the global stock market has tumbled more than 25%, bringing the longest bull-market in history to a screeching halt.

Many investors have been expecting the end to this ‘Euphoria’ stage and have been doing so since Trumps appointment, however no one could have predicted that the slowdown would have been caused by a pandemic.

Indeed, economic cycles are inevitable, and this hasn’t been clearer over the past month. The below chart shows the typical phases of a cycle and how long the ‘Euphoria’ stage had been extended. When we see a sharp fall in the stock markets, this creates ‘Anxiety’ and ‘Fear’, but the market will always revert back to the mean.

What is important to note, and a key take away from the diagram, is that it is key not to buy at the ‘high’ and sell at the ‘low’.

Unfortunately, investors are at the mercy of the financial markets, and we cannot predict how long the fall will last and when the tick back will start, however we must remember that investing is a long-term objective and shouldn’t be for the short term.

Why have stock markets fallen so much?

The price of a stock/share is a true reflection of a company’s value.

With the stock markets, these prices reflect investors’ expectations of companies to generate future earnings, what they can gain in profits and the volumes of cash flows

Therefore, when investors are collectively optimistic about company prospects, the stock market goes up. When they become nervous, expecting slower or even negative growth, the stock market falls. And when there’s widespread panic, they can crash, which is what we have recently seen.

The problem is that the 'Euphoric' stage we mentioned earlier drove these stock prices so high that they inevitably fell, based on the realisation that they were overvalued.

This pandemic has caused chaos around the globe, and now governments have had to step in and act which has created problems for most businesses based on their quarantine measures.

Travel and leisure companies are the first to be impacted, but the knock-on effect could see businesses across many industries obstructed.

On the contrary, some companies are also benefitting from the pandemic, such as delivery companies, cleaning product manufacturers and technology companies, however these are in the minority.

The majority of markets capitalise on consumption. In the UK, our GDP function is constituted by approximately 60% consumption, and with the lockdown, this is anticipated to drop sharply.

It’s not all about Coronavirus though. Oil is also playing a part in the recent volatility. Saudi Arabia has sparked an oil price war with Russia, causing oil prices to plunge last week.

This puts pressure on the big energy companies that make up so much of the global stock markets. Whilst Coronavirus is seen to be a short to medium-term economic issue, oil could be a longer-term concern.

We are here to guide you through the storm

It is never easy to see the value of your investments go down, especially when they have by the amounts we have seen over the past 5 weeks.

It is important to note that that the scale of the most recent falls hasn’t been seen in over thirty years, and investors should know the risks that the markets have to offer.

Based on this, we always make sure that we operate our client’s portfolios in the right risk brackets - which matches their attitude to risk. Our portfolios are carefully designed to ensure we protect on the downside and then capture the upside by diversifying well across the spectrum of assets.

Some investors may be tempted to sell everything to avoid further losses and wait for the markets to recover before investing again. In practice though this is very difficult to do and could result in worse returns than if you’d just stayed invested.

There’s no clear signal when we reach the bottom of the market. They can recover quickly, meaning you could miss out on the gains of a potential market rally.

It is important to take a long-term view with this and to remember that economic cycles are inevitable and that we have had worse market falls than this one has been so far. Historic data has shown us that over time, the markets will always recover - and this will be reflected in the true price of where the stock markets should be.

There are no guarantees and there is no telling when or how long this recovery will take, however by staying invested for the long term, you’re likely to improve your returns over time.

We retain a strong bias to liquid assets to allow us the flexibility to position ourselves through this market.

As economic visibility remains low on many levels - economic activity, policy action, Coronavirus impact and functioning of financial markets - our approach is not to be pre-emptive or anticipate when the best time is to come in and out of the markets.