A Trader's Musings: The Covid-19 Crash (Part I)
What happened in the financial markets in 2020 has left enough material to write volumes in future history books. We thought it would be interesting to present a brief overview of what had occurred last year through a trader’s perspective, with a deeper dive into the market dynamics.
On January 21, 2020, rumors of a virus outbreak in China began to spread widely. U.S. equity indices sharply fell, erasing early January gains. American Airlines, United Airlines, and Delta Airlines quickly announced they would curb travel between China and the U.S.
Equity markets shook off the news and returned to positive territory the following week. As the number Covid-19 cases sharply rose, China implemented a national lockdown through Lunar New Years to contain the spread. News broke of the virus spreading to Europe and the U.S.. However, U.S. equity markets were unfazed and continued to rally to all-time highs.
What happened next was nothing short of astonishing.
In mid-February, panic finally struck the financial markets; equity prices began to fall. Between February and March 2020, U.S. equity indexes fell by more than 30 percent. Lockdown measures were implemented across the globe in effort to curb the spread of Covid-19. In the U.S., unemployment numbers went from 3.8% in February 2020 to highs of 14.7% in April.
With transportation restrictions and global lockdowns, affected sectors such as travel, retail, dining, and energy were hit hard. As markets continued to fall, cross-asset correlation increased. For example, precious metals (such as gold and silver) are traditionally viewed as a flight to safety asset. However, during the height of the March 2020 panic, equities, energy, precious metals, and cryptocurrencies were positively correlated and asset prices fell.
The equities sell off reached its peak March 23; on March 24, equities began their meteoric rise. In the U.S., despite rising numbers of Chapter 11 bankruptcy filings, elevated unemployment numbers, and multiple waves of COVID-19, equity markets rallied in a spectacular fashion, closing up over 60 percent on December 31, vs. March 2020 lows.
What caused this drastic move in asset prices? FUD — fear, uncertainty, and doubt — stemming from the unmitigated spread of the novel coronavirus and the resultant devastating effect on global productivity sparked risk-off signals in the financial markets. With rising realized volatility in equities, popular risk-parity funds systemically sold their equity exposure and allocated it to alternative assets.
CTA funds chase momentum, and added to selling pressure in equity futures. On top of all this, market regulators in Asia and Europe quickly enforced short-selling restrictions and bans; however, none was implemented within the U.S. This meant that American equity and index futures (both highly liquid and traded extended hours) were a target market for global asset managers to maintain short equity exposure. All this became a negative feedback loop, which added selling pressure to U.S. equity markets.
So why did asset prices bounce back so quickly? On the macro front, Central Banks across the world unleashed monetary easing policies. In the U.S., the Federal Reserve quickly lowered interest rates to zero and Congress passed massive stimulus bills to support affected industries. Airlines (who were suffering massive cashburn due to drastic travel declines) were provided a lifeline by the government and avoided bankruptcy.
Additionally, signs of virus containment and hopeful rhetoric around vaccine development rhetoric eased FUD and unleashed euphoric buying in global markets. During the height of the pandemic, many businesses and organizations pivoted to remote-based solutions; this accelerated technology adoption and integration globally, which proved to be extremely positive for technology growth.
As a result, technology stocks exploded in value. As equity prices recovered, realized volatility decreased, which signaled risk-parity funds to sell other asset classes and allocate toward equities. All this became a positive feedback loop, which added buying pressure to U.S. equity markets.
I am neither a professional economist nor journalist. Rather, I’m a curious learner who likes to explore causality in the events we experience.
I hope you enjoyed this humble trader’s musing on the 2020 Covid-19 stock market crash. In future articles, I’ll examine other aspects of the Covid Crash of 2020.
Many other interesting financial events occurred in 2020, such as the rise of meme stocks, oil futures trading negative, and the cryptocurrency boom. If you’re interested in learning about my thoughts on these topics, let me know and we can discuss them in future articles.
About the author: Mark Xue is Director, Portfolio Risk / VolArb Strategies at Kaiju Capital Management.