Covid-19 – On the Tips of Icebergs

Why Stock Markets Went Down and Then Bounced Up

As the Hammer strategy to combat the Covid-19 virus evolved to prioritize health through physical distancing, whole chunks of the global economy shut down.¹

¹ See our article Covid-19 – Hammer & Dance Trend Rethink at

Stock markets gasped, plummeting from peaks around Feb. 20th, to bottoms 30-40% lower just a month later. A crashing oil price didn’t help either, with slumping demand exacerbated by the Saudis stepping up production.  

In a dramatic turn, many stock markets have recouped a chunk of their worst losses, darting 20-30% upwards from the lows in just the past 3 weeks.

Why the reversal? Two reasons. Demand and The Big Rescue

1. Rebalancing Demand

Fresh underlying demand for stocks emerged due to asset allocation decisions, since bonds had outperformed by a wide margin in Q1. Balanced portfolios targeting an asset mix such as 60% stocks and 40% bonds needed to buy stocks to rebalance back within the target range. This uplift in demand is a temporary phenomenon that tails off sharply over a couple of months. Normally it ends when the calculated amount at the end of Q1 has been reallocated.

Our view is that rebalancing flows will not provide the legs necessary for the current rally to continue. In this instance, the quick run up in stocks revalues the existing stock portion in the portfolios, reducing the calculus on the amount needing to be purchased to get back towards target.

2. Authorities to the Rescue

Canadian authorities (and those of some other countries) have been acting expediently and boldly to offset the economic impact of Covid-19 by unleashing a goliath set of emergency measures. To their credit, their initiatives have generally been well-crafted and focused, especially considering the scale & speed of the appropriate response. Good job government, good job.

Government programs seek to supplement sudden wage loss due to Covid-19 and keep employees connected with their companies while staying at home. Additional programs offer funds and credit to companies that are facing sudden revenue shortfalls due to the virus. They can be characterized as financial bridges which enable firms to bide their time while virus suppression measures remain in place.

Central banks, for their part, are proceeding with a combination of established and unprecedented measures. Standard monetary measures include interest rate cuts to support consumers and businesses, and enhanced funding operations with financial institutions to ensure sufficient liquidity for properly functioning markets.

The Bank of Canada just minted a new slate of shock and awe policy actions in its role as lender of last resort. Asset purchase programs have been created that not only enable the Bank to buy Provincial government bonds, but corporate bonds in the open market as well.

The government programs improve corporate income statements. Affected revenues are eligible for a top-up. Expenses are defrayed by subsidies and deferrals. Voilà! The bottom line, which is corporate earnings, are shored up to some extent.

The central bank measures, particularly by taking a further step with the asset purchase programs, improve corporate balance sheets. The central bank is engineering the ability to refinance more debt at lower prices than market forces without its participation would dictate.

The aggregate outcome? Earnings’ shortfalls will be less grim than otherwise, labour remains on tap, and reduced pressure on debt translates into upside for equity. In sum, the measures and messaging of the authorities end up goosing up the stock market to the benefit of shareholders.

The Tips of Icebergs

Our authorities here at home have done a pretty good job of bringing the Hammer down with physical distancing for good health, and of rolling out big financial rescue measures to soften the economic blow.

The metaphor of an iceberg, much larger beneath than above the surface, is apropos for the financial markets. Above the surface are key interest rates and stock exchange prices that we readily see pricing bonds and stocks. They are also the primary pricing determinants of a much larger and more complex set of financial instruments beneath the surface. These deeper risks add further credence to why the authorities are throwing so much at this.     

I wonder if a similar metaphor applies to global health?