Covid-19's impact on financial markets

Overview of Covid-19

Covid-19 is a novel coronavirus that was initially found in Wuhan, China in late 2019, and it did not take long for the airborne virus to reach other parts of the world.

The first confirmed cases of the virus in the United Kingdom, the United States, Japan, India, France, and a dozen more countries were reported in January 2020. By mid-March, Covid-19 spread like wildfire, leading to tens of thousands of fatalities and mass panic. Many countries declared states of emergency and went into national and regional lockdowns to curb the spread of the virus.

Emerging from lockdown in the summer of 2020, governments witnessed the social and economic damage Covid-19 had caused, and set out roadmaps for educational facilities, offices, shops, and public spaces to reopen. As the death toll continued to climb, governments and central banks offered monetary and fiscal support in phases for individuals and private sector businesses.

Throughout the rest of the year, pharmaceutical companies continued to work on developing a vaccine, and resurgences of the virus resulted in regional lockdowns, delaying economic recovery. Many international borders remained closed.

By year-end, global Covid-19 cases reached a record 82.83 million, with over 1.8 million fatalities. The global economy and financial markets had been through the wringer, and the world was ready to leave 2020 behind.

The impact of Covid-19 on the economy

The pandemic had a sizeable impact on the global economy. On the whole, the International Monetary Fund (IMF) estimates that the world economy, shrank by as much as 3.5% in 2020.

However, it must be said that this downturn was not as severe as initially estimated and varied across sectors and countries. In general, while significant dents in the economy were made in the first half of 2020, many countries managed to see slow but steady recovery in the second half.

Consumer activity

Consumer activity in 2020 can mostly be summed up through radical changes in consumer behaviour. In spring, travel and food service sales dipped dramatically. However, there was an explosion of panic buying of essential items and a mass migration from in-person to online shopping. Even as lockdowns eased in the second half of the year, people stayed at home and online, and eCommerce’s share of global retail trade rose from 14% to 17% in 2020.

Global trade

On the supply side, lockdowns and closed borders caused by Covid-19 led to disruptions in labour markets and supply chain bottlenecks. Factory output and agricultural exports declined in the first few months of 2020, and nearly every member of the Fortune 100 was disrupted by production delays and shortages in China. Shipping and transportation constraints also added to inflationary pressures. However, global trade made steady recovery in all major goods categories in the second half of 2020, supported by fiscal stimulus in advanced economies in North America, Europe, and Asia. By year-end, global trade was only estimated to have fallen by 5.3%, compared to the projected fall of 9.2%.

Unemployment and labour income loss

With mass panic, regional lockdowns, and Covid-related restrictions in place, labour markets were disrupted on a historically unprecedented scale. According to the International Labour Organization (ILO), global employment increased by 33 million in 2020, increasing the unemployment rate from 2019 by 1.1%, to 6.5%. With unemployment comes labour income losses.

Inflation

Covid-19 accelerated the global trend of disinflation in advanced economies as people sheltered in place. For developing economies already on high inflation paths, the price level continued to rise. By the end of 2020, global inflation rate had declined from 3.47% in the previous year to 3.18%.

Key responses to Covid-19

As Covid-19 ravaged the world, global leaders were called to respond to the economic fallout. Governments, global organisations, and central banks offered financial aid by enacting sizable economic stimulus measures to combat the disruption caused by the pandemic. For the most part, these measures lessened the impact of Covid-19 on the real economy and on financial markets.

What is an economic stimulus?

Economic stimulus refers to fiscal and monetary measures and policies enacted by governments and central banks during times of recession or large-scale financial disruption.

Fiscal stimulus, enacted by governments, aims to reduce taxes or regulations and to direct government deficit spending toward key sectors of the economy to encourage private sector consumption. The idea is to rely on the private sector’s spending to increase aggregate demand and hopefully boost the economy out of recession.

Monetary stimulus refers to actions undertaken by central banks, such as lowering interest rates or purchasing securities in financial markets to make it easier for people to borrow and invest.

The fiscal and monetary aspects combined create a stimulus package, which governments push to salvage a faltering economy.

Economic stimulus measures enacted to combat Covid-19

Governments

By September 2020, governments around the world had issued pandemic loans and grants of varying sizes to keep the economy afloat. These pandemic grants included wage support, welfare benefits to individuals and households, tax deferrals, rent concessions, industry grants, and subsidies for small and medium enterprises and corporations.

Central banks

In advanced economies, central banks also rapidly intervened with the primary targets of easing financial stress and maintaining market liquidity. Between March and April, central banks in the US, the UK, Japan, Canada, and the Eurozone implemented fiscal backstops, new lending operations, and the cutting of interest rates.

All five central banks also activated private sector asset purchase programmes to support the flow of credit to non-financial firms. This included increasing the size of their corporate bond and commercial paper purchase programmes.

Additionally, the Federal Reserve, the European Central Bank, and the Bank of Japan increased the availability of their currencies abroad thorough swap lines and the opening of repo facilities. This maintained foreign exchange liquidity in financial markets, and the Federal Reserve responded to the appreciation of the US dollar by reducing the cost and extending the maturity of the standing swap lines.

Global organisations

International efforts were organized to help vulnerable developing countries. These include donor countries providing monetary assistance, and suspending debt service payments for the world’s poorest nations to aid Covid relief.

These economic stimulus measures, for the large part, softened the severe blow Covid dealt to the economy, and generous stimulus packages steadily restored market functions near the end of 2020.

Market performance in 2020

The economic turmoil caused by the pandemic was reflected in financial and commodity markets. However, Covid’s impact was not straightforward, and taking into consideration the economic stimulus measures implemented by governments and central banks, various asset classes were affected in different ways.

Global equities

The most significant financial impact the pandemic had was the stock market crash that lasted from mid-February to late March, when the first wave of Covid-19 officially began in Europe and North America. Collective panic triggered massive sell-offs of global equities.

On 16 March, the Dow nosedived 3,000 points and closed at 20,188, a drop so severe that the New York Stock Exchange (NYSE) had to suspend trading several times during the period. The S&P 500 Index also lost one-third of its value during the crash, plummeting to 2,304 at its lowest point the day before.

However, over the months, as people adjusted to pandemic living, global equities made a comeback. By August, the S&P 500 had regained all of its losses, and global markets continued to rise. There was also an increased interest in pandemic stocks. As people stayed home, they invested in telecommunications software company shares, healthcare stocks, biotech and medical stocks.

In just one year, video-conferencing software Zoom saw an incredible surge of 450% in stock price. Pharmaceutical companies, in a race to develop a Covid vaccine, also saw huge surges, with the Moderna stock price increasing more than 434%. By year-end, the Dow and S&P 500 closed at all-time highs of 30,606 and 3,756 respectively.

Bonds

In the spring of 2020, companies faced liquidity challenges and turned to the corporate bond market, resulting in sharp increases in corporate bond yields. This was motivated by the need for immediate cash flow and the desire to build a cushion for future economic uncertainty.

The increase was sustained in Q2 2020, to a lesser extent, and the second half of 2020 saw bond yields returning to pre-pandemic averages with the expansion of quantitative easing by central banks. However, as a result of the surge in bond issuance in the first half of 2020, the global outstanding stock of non-financial corporate bonds reached $14.8 trillion by the end of the year, an increase of 8% from 2019.

Global energy

In the spring of 2020, global demand for energy – most notably, oil – fell, resulting in rising inventories and sharp falling prices. As market indices declined and the dollar appreciated, Brent crude oil dropped close to $20 a barrel in March, and oil producers agreed to reduce global supply by 10% (9.6 billion barrels), only restoring production near the end of the year. Through late November, Brent crude oil was priced in the range of $40 to $44 per barrel, only breaching the $50 mark in December. It was a catastrophic year for global energy, but it managed to make a decent recovery and ended 2020 with positive prospects.

Other commodities

Other commodities were affected in different ways. In the first half of 2020, supply chain disruptions handicapped the production and shipment of agricultural products.

However, there was a turnaround in the second half of the year, with export and import volumes increasing steadily.

In this time of market turmoil, gold spent much of 2020 fulfilling its traditional role as a hedge against market uncertainty. Investors flocked to gold-backed ETFs, and a record 877 tonnes (equivalent to US $48 billion) was added to global holdings. By August, the price of gold had rocketed to a historic high of $2,067.15, despite the total annual gold supply taking a hit due to pandemic-related disruptions in mine production. This price consolidated in Q4, ending the year with a 25% Y-o-Y return.

Forex

In the first half of 2020, the forex market experienced periods of increased volatility and varying liquidity. Covid’s impact on currencies depended on their market standing and their government’s policy responses. While central banks scrambled to adjust their monetary frameworks in the spring, corporate and individual investors funnelled their capital into safe haven currencies such as the Japanese Yen (JPY), the US Dollar (USD), the Euro (EUR), and the Swiss Franc (CHF), all of which saw substantial growth. Exchange rates of emerging market economies plummeted in April but managed to rebound and stabilise throughout the course of 2020, with the extension of the US Federal Reserve swap lines and the opening of a repo facility.

Cryptocurrency

Cryptocurrency is a highly speculative asset that diverges from traditional regularised systems within financial markets. With the stock market crash and general economic uncertainty, investors pursued portfolio diversification with urgency. Driven by herd behaviour and recession fears, many turned to crypto. In 2020, Bitcoin rose nearly 300% from March to December, outperforming the combined gains of gold and the Dow stock market by a factor of 10.

Takeaway for investors from Covid-19

Arguably, one of the main takeaways from Covid-19 for investors is the importance of portfolio diversification. Many of us have been advised to not put all our eggs in one basket, lest the basket should break. As Covid-19 wreaked havoc on financial markets, not all asset classes were affected equally. In times of heightened market volatility, those who diversified their investments had healthier portfolios and potentially experienced less strain on their mental well-being.

Try your hand at pandemic investing with SaxoScenarios

With an adequate knowledge of the economic consequences of Covid-19, why not go back in time and try your hand at navigating the financial market back then with SaxoScenarios, our free stock market simulator?

Navigate news stories as they break and make decisions based on market performance and global events. Test your trading skills and see how you would fare in this tumultuous time compared to friends, family, and investors around the world.