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ANALYSIS

On the rebound

The recent state of alarm declared by the government has ramifications for all sections of society which are being affected to different degrees. The travel industry, including the airlines, hotels and cruise companies, is one of the sectors most affected. It is also having an impact on industrial and manufacturing companies at both ends of the spectrum with them being unable to source raw materials and parts, while at the same time sales markets are shrinking fast. As a consequence, companies are laying off employees resulting in the spectre of mass unemployment.

The effect of all this on the economy is obvious. Reduced industrial activity means falling sales, which results in decreasing profitability. This in turn is reflected in the share prices of these companies as investors begin to offload shares with there being more sellers than buyers. Markets end up in a race to the bottom as it becomes a self-perpetuating phenomenon.

We have seen this in the performance of the financial markets during the last few weeks. Both the UK FTSE 100 and the American Dow Jones Index have shed one third of the value of their quoted securities. Talk is of a financial crisis and the probability that the economies of countries will enter into recession as economic activity contracts. This however is not a financial crisis but rather a global health one that has served as a catalyst for markets to implode.

How soon will the financial markets recover from this downturn? If history is anything to go by the answer is relatively quickly. Investors were terrified in October 1987 when the FTSE 100 Index fell by 11% on Black Monday and another 12% the next day. Nevertheless share values soon recovered. There was a similar scenario in 2000 when overvalued technology companies brought an abrupt end to the so-called technology and digital revolution. The FTSE 100 fell more than 40% at the time however it took less than two years for the market to get back to where it was before. Similarly the global financial crisis of September 2008 was set off by the sub-prime mortgage crisis in the United States which resulted in the bankruptcy of the US investment bank Lehman Brothers and UK banks struggling having overstretched themselves. Royal Bank of Scotland overpaid to acquire the Dutch bank ABN Amro while Lloyds Bank was persuaded by the government to rescue the bank HBOS. Both RBS and Lloyds ended up being bailed out by the government. Despite this global financial crisis, it took the markets little more than a year to recover.

The current coronavirus pandemic is very much a global health crisis which has precipitated a collapse in the world's financial markets. Whereas the previous crises only affected the world of finance and its institutions, the current situation affects everyone. The lockdown and its consequent restrictions on movement mean that the sense of relief and freedom when life finally returns to normal will in all probability serve to give a huge impetus to the economy as people go out and spend on restaurants, travel, holidays and all the things that they have been unable to do during the lockdown. As a result the recovery is likely to be much quicker than the reaction to the earlier crises.