By Lidiane Cunha
The strong impact of a global crisis on financial markets is not historically new. Climate catastrophes, pandemics, political turmoil, and military conflicts can compromise our safety, health, infrastructure, and international relations with other countries. As these drastic changes also affect businesses and the global economy, they fuel considerable uncertainty, a major threat to investments in financial markets.
The Covid-19 pandemic, unfortunately, fits into this profile, damaging leading economies and threatening stock markets around the world. In Canada and the United States, the stock market quickly went down more than 30% and erased most of the gains achieved over the past few years. As both countries have not yet experienced the peak of the Covid-19 outbreak, it’s unclear what is likely to happen in the next weeks. Five finance researchers from the University of Ottawa’s Telfer School of Management explain why the Covid-19 pandemic has turned the financial markets into a roller coaster, what’s unique about this crisis, and how corporate leaders and government officials can support the economy during these challenging times.
Why does a pandemic affect the market?
“Threats associated with the new coronavirus have severely affected the fundamental operations of firms across the world, their market access and supply chain networks, resulting in a sharp decrease in stock prices. In addition, investors, financial analysts, and investment banks have become too nervous due to the uncertain future of the business world. This ‘fear of the unknown’ has led to an increased stock market volatility. This can explain why many world leaders are trying to give assurances to investors and other market participants. However, negative news on COVID-19 seems to overpower the ‘fragile hope’ for the time being.”
What is unique about this financial crisis?
“There are two distinctive features of this market turmoil that distinguish it from past ones. The first is the speed at which the stock prices went down. From February 20th to March 23rd the S&P/TSX Composite index went from 17,944 to 11,228; this is a 37% drop and it erases all the gains since October 2011. The second distinctive feature is that the steep decline in asset prices affected not only the stock markets but also other asset classes such as commodities. Even gold (considering an investment in the SPDR Gold Shares), which is typically considered a safe-haven asset, has experienced a 4% decline during the same period. By contrast, during the 2007-2008 stock market crash, gold provided a hedge, delivering positive returns for investors. Thus, it appears that diversification across asset classes is not as effective as many would believe in the context of the current market uncertainty and turmoil. In my research, I would like to better explore the reasons behind these phenomena.”
Why is corporate transparency about the development of the crisis so important?
“In uncertain times, updates by public officials could ease the anxiety that one might have about the future. In the wake of the COVID-19 pandemic, corporate disclosure is similarly important. Corporate leaders can provide their shareholders and investors with regular updates about how the pandemic is affecting their business operations. It’s also advisable that companies devise an effective disclosure strategy. They could start by being transparent about the challenges that they are facing in the short-term. For example, many companies are currently facing disruptions to their business operations due to physical distancing, travel restrictions, or problems related to broken supply chains. They should clearly communicate what they know and don’t know, how the pandemic is affecting them, and how these issues are being addressed. Firms should also consider issuing more regular press releases or using other communication tools such the social media. These communication efforts could help investors, analysts, and other key players in the market to better understand the depth and breadth of the pandemic’s effect on firms’ operations, hence lessening the concerns and uncertainty that investors may have about the viability and prospects of their investments.”
What’s the role of government?
“The nature of this event provides better justification of why the government needs to step in to bail out, if necessary, whoever may be in financial trouble. This was not the case in 2008, when many people would have to take the loss because of poor investment decisions. In today's markets, there is a better reason why governments should interfere with the markets. The unique challenge that government officials face today is how to weigh people's lives against the potential recession created by physical distancing and lockdown. Without robust data on death rate and the virus behaviour, most world leaders must plan around the worst-case scenario and its impact on the society. This explains the increasing pressure on government officials to enforce nation-wide lockdowns. Once the spread is controlled and we have better estimates, the governments’ next step is to ensure that their regulations are backed-up by new data.”
Jonathan Yumeng Li
How can the government support small- and medium-sized firms?
“Currently our economy is receiving a drastic negative shock, and, of course, small businesses are no exception. We have already seen a significant increase in demand for credit. Firms that were viable until recently now seek financing in order to survive the current crisis. More than ever, government finance programs that facilitate credit and loans are essential, particularly for young small businesses that have shown a healthy growth before the crisis. These interventions can support these businesses to get back on the path of growth and regain profitability once the world has recovered.”
Ali Akyol is an Associate Professor in finance. His research mainly focuses on the effect of governance related regulations, the board of directors, firm disclosure and financial misconduct on shareholder value.
Shantanu Dutta is an Associate Professor and a Telfer Fellow in Global Finance. His research focuses on mergers and acquisitions, media coverage and financial decisions, corporate governance, market efficiency, dividend policy and technology management.
Jonathan Yumeng Li is an Associate Professor in business analytics. His research interests focus on business analytics, operations research, and financial engineering. At the centre of his work are risk management problems that involve quantifying and modelling risk.
Fabio Moneta is an Associate Professor and a Royal Bank of Canada Fellow of Finance. His research interests concentrate on investments, institutional investors, trading behavior, mutual fund performance, and empirical asset pricing.
Miwako Nitani is an Assistant Professor in finance. Her research focuses on the roles of banks, public policy, entrepreneurial finance, and behavioural finance.