The Week: Bye-bye the ‘V’ shaped recovery; hello the ‘L’ shape

A V-shaped recovery now looks vanishingly unlikely, but could any good come of the financial market meltdown?

  • Chancellor Rishi Sunak has made it clear that this is not just a health crisis, but an economic crisis
  • The crisis has exposed the vulnerability of certain parts of the market: highly indebted businesses, poor business models and illiquid assets
  • If business learns from its mistakes, a more sustainable capitalist model may result

Anyone hoping for a V-shaped recovery in stock markets will have been sorely disappointed this week. The bad news came in waves: restaurants, theatres and cinemas would need to close, sports events would be cancelled, people should work from home and avoid contact where possible. Then schools started to close and it became clear that this wouldn’t just be for a few weeks but could last for months on end. Chancellor Rishi Sunak made it clear that this was not just a health crisis, but an economic crisis.

It is difficult to remember a tougher week on markets. Investors weren’t being seduced by the big numbers being thrown about by the Federal Reserve or Chancellor Sunak. The FTSE 100 has now lost around a third of its value and doesn’t appear to have found its floor. Today, government bonds started to fall as well as investors desperately looked for liquidity. Cash was the only game in town.

There were the usual areas of vulnerability: the UK property funds all shut their doors to redemptions, once again making the argument for illiquid assets to be held only in a closed-ended structure. Perhaps more importantly, on a systemic level, were the problems in ETFs – particularly fixed income ETFs. Some investors have long feared that fixed income ETFs gave the illusion of liquidity in illiquid markets, such as high yield bonds, and were ripe for problems. It took some time, but here are those problems.

It is clear the virus will create irreversible problems and investors shouldn’t simply expect a bounce-back. Can parts of the leisure sector survive? What will it do to unemployment and consumer spending? What will that do to property values? Will default rates spike and blow up the high yield bond market?

There is a more optimistic take. This may prove to be creative destruction in a capitalist world that had looked increasingly stale. The sharpest, most tech-savvy businesses look set to emerge from this crisis with flying colours. It should prompt crumbly old indebted businesses to re-evaluate their corporate practices and modernise, having been exposed as vulnerable by the crisis. It should do the same for parts of the financial markets.

It is too soon to predict how this crisis will end, but if business and financial markets address the vulnerabilities that have been exposed by it, then a better, most sustainable capitalism may result.