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By: Martin Layar
Editor: Akshat Daga
Illustration by Chen Hsuan Ju
1.0 Abstract
Since COVID-19’s inception in end-2019, millions have been infected physically. The infection’s impacts extend beyond the physical aspect to the overlapping technological, economic, social and of course, financial impacts. COVID-19’s outbreak has caused nations to go into large-scale containment measures and hence, led to drastic disruption to economic activity. There were, inevitably, spillover effects on financial markets as well. This article gives the reader a glimpse into the socio-economic impacts of COVID-19 financial markets with emphasis on the Standard & Poor 500 (S&P500) Exchange-Traded Fund (ETF), looking into a few key reasons as to whether it is still a good investment amidst this new global pandemic. Another investment class, defensive industry ETFs, would also be touched on slightly in this article.
2.0 Impacts of COVID19
Although it is an unpopular opinion, COVID-19 can be seen as a double-edged sword, bringing both positive (Nelson, 2020) and negative impacts (Craven, Liu & Mysore, 2020) throughout the world in a vast number of different areas, including the social sector, public health and the economy itself. Not surprisingly, COVID-19’s outbreak has benefitted the environment in many areas as the emission of greenhouse gases are largely reduced (Henriques, 2020). However, the negative impacts filter into various integrated areas of the world. There are various considerations of a “new normal” (Flint & Kotwal, 2020) brought by the pandemic. The broad economic impact arising is major economic losses with trickle-down effects on various sectors of the economy and is likely to last a long time (Choudhury, 2020). As various economies close down or are crippled (Swartz, Reeves & Carlson-Szlezak, 2020) by the pandemic, there are various implications on other markets as well.
2.1 Impacts on Markets in general
In financial economics, “people’s expectations are already priced in” and “how prices get formed today is based on what you think will happen in the future” (Goh, 2019). This would mean that whatever is expected by rational economic agents in the markets will be factored in to cause fluctuations in price. COVID-19’s impacts on financial markets would be negative, but only for the short-term (He, Liu, Wang & Yu, 2020). There are both supply-side and demand-side effects of the pandemic. Globally, the pandemic would cause Gross Domestic Product (GDP) of nations to fall and the falls would be attributed to both demand and supply-side losses; based on previous epidemics like SARS and the Influenza pandemic in 1918, GDP of affected nations would fall by close to 4 percentage points (Boissay &Rungcharoenkitkul, 2020).
2.2 Impacts on Financial Markets
The nature of global catastrophes like COVID-19 is that during these crises, prices would be expected to fall (Davidson, Bomey & Menton, 2020), and they do indeed fall, not just in basic economic markets but also financial markets. While still evolving, COVID-19’s impacts on financial markets have already caused a global recession with trillions of dollars lost in a multitude of asset classes like bonds, oil and equity prices (Srinivas, Schoeps & Ramsay, 2020).It is worth noting that for the first time in history, the price of oil fell to negative zones where holders were actually willing to pay others to take oil off their hands (Hansen, 2020).
Figure 1 below depicts the drastic fall in the 10-year US treasury yield. It has fallen to record-low levels.
Figure.1: 10-year US Treasury Yield
Stock markets have also become far more volatile as a result of the pandemic, as shown in figure 2 below. Volatility levels have been shown to spike up as COVID19’s outbreak continues to evolve.
Fig.2: Stock market’s expectation of volatility based on S&P500 index options
These are just some of the many effects on various markets of financial assets. The general sentiment is that with all this volatility, there is bound to be a lot of uncertainty, at least in the short run, for the financial markets.
2.2.1 S&P500
The S&P500 index is the largest ETF in the world as of 2020, with an excellent and long trading history (Shukla, 2020). It has been traded for over 90 years since 1928 (“S&P 500 Historical Annual Returns”, 2020), tracking the top 500 large-cap USA companies (Amadeo, 2020). Since its beginning in 1927, it has averaged 10% annual returns (Maverick, 2020), its value rising from just USD115 in 1980 to over $3000 today (“S&P 500 Index”, 2020). The index is quite well-diversified across the top 500 companies in the USA, across various industries including technology, oil, investment, healthcare and others (Merriman, 2019). Figure 3 below shows the S&P500’s price history from 1980 onwards.
2.2.1.1 COVID19’s Impact on the S&P500
As the pandemic outbreak intensified in March 2020, the S&P500 index fell sharply from USD3373 in mid-February all the way to USD2237 in mid-March, in just one month, as reflected by Figures 4 and 5 below.
Figure 4: S&P500 price on 20 Feb 2020
Figure 5: S&P500 price on 23 March 2020
The price of the S&P500 tanked by about USD1000 in just one month because of the enhanced COVID19 concerns. However, it does appear to have recovered back to pre-dip levels as of June.
2.2.1.2 Why S&P500 is still a good investment despite COVID-19
This article offers 2 overlapping reasons why S&P500 is still worth investing in during COVID19 times:
1. It is very well-diversified and robust as an investment
2. It is resilient to market shocks and has survived past crises
2.2.1.2.1 Well-diversified robust investment
There are years with positive returns and years with negative returns, but still averages 10% yearly returns (Maverick, 2020). While volatile in the short run, its average appreciation is maintained in the long run. There is sufficient diversification across a large variety of industries in the S&P500 (Lemke, 2020) to provide hedging against market risks (Bowman, 2019). Figure 6 below shows the average yearly returns of the S&P500 in a normal distribution curve, as proxied by USA Large company stocks.
Figure 6: Large company stocks average returns
There were years with sharp declines, such as 1931 and 2008, but the distribution is left-skewed, indicating an overall positive return. A well-diversified portfolio would minimize the unsystematic risk of the investment (Financial Fitness Group, 2020). While not necessarily removing systematic risk, because of diversification, the S&P500 is well-established enough, comprising of many industries and would be well-equipped to withstand even economic shocks.
2.2.1.2.2 Resilience against market shocks
S&P500 has been very resilient to major market shocks since its launch. In figure 6 above, during financial crises like in 2008, it experienced major losses but has not yet been delisted. Past crises that S&P500 survived without delisting include (“11 historic bear markets”, n.d.):
- 1929 great depression
- 1961 Cuban missile crisis
- 2002 dot-com bubble burst
- 2008 global financial crisis
S&P500 has survived all these shocks and still survived without delisting. As in figure 5 above, even after 2020’s COVID-19 crisis happened, S&P500 has demonstrated strong signs of recovery. Professor Jeremy Goh highlighted that the S&P500 will, based on “qualitative and quantitative historic evidence”, recover in value after crashing due to market crises (Goh, 2020).
2.2.2 Defensive industry ETFs
Defensive industries are those which continue to operate and serve people’s needs with necessity goods and services despite economic downturns (“Corporate Finance Institute”, n.d.). These include sectors such as food, electricity and medical. Relatively unaffected by economic recessions or expansions (“Corporate Finance Institute”, n.d.), these defensive industry stocks are likely to remain strong amidst crises like COVID-19, and some examples are Medtronic and Ball Corp (van Doorn, 2020). While they may not directly rise in value because of COVID-19, they would remain robust, with some continuing to be able to pay out dividends. Specific to the medical industry, investment opportunities await. Gerstein, 2020, believes that even for the defensive medical industry, diversifying into multiple ETFs including the Health Care Select Sector SPDR Fund XLV (A part of the S&P500) and First Trust NYSE Arca Biotechnology Index Fund (FBT) is key (Gerstein, 2020).
3.0 Conclusion
The S&P500 and medical ETFs both offer investment opportunities amidst the current COVID-19 crisis. S&P500 would prove to be a robust investment in the long term despite short term volatility due to its ability to withstand crises. However, at the heart of both S&P500 and medical ETFs as asset classes are the fact that they are both well-diversified and would therefore be expected by the markets to recover even after crises come and go. These 2 asset classes continue to garner strong expectations by investors and economic agents to stay valuable and strong even amidst crises. They can be considered good investments in the long term, especially so when COVID-19 brings about a “new normal”. Whilst potentially volatile during the short run, they would make potentially excellent long run investments especially if bought during a downturn and reduction in index price.
References
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