The impacts of the coronavirus on the global economy: Part V Is a comparison with the Great Depression possible?

More and more commentators and economists are comparing the current economic crisis to the 1929 depression (also known as the Great Depression). For some of them, the current crisis is even worse. Are they right? In my humble opinion, they are wrong.

First of all, the Great Depression was caused by a stock market crash (that started on October 24, 1929). On the other hand, the current economic crisis is voluntarily induced by governments as a policy response to a global health crisis. Thus, the turbulence we are observing on stock exchanges around the globe is the consequence but not the cause of the current economic situation. The causes of the stock market crash of October 24, 1929 were mainly consumerism, easy credit, and speculation. Its consequences were mainly bank failures, hoarding, massive job losses, and poverty. Second, if the causes of the Great Depression and those of the current crisis are not the same, their consequences are not similar either. Currently, investors have fear, but they have not lost confidence in financial institutions. Millions of people are not currently employed, but they have not definitely lost their jobs. Third, the Great Depression lasted almost a decade (from 1929 till the outbreak of World War II), whereas the current crisis is hopefully coming to an end, since governments have started preparing plans to exit the lockdown restrictions they imposed some months ago.

It is true that the stock markets have been very turbulent since the outbreak of the coronavirus disease. On March 13, the situation on the major exchanges was the worst record over the past two decades (see Figure 1). Since then, it has been gradually improving. Between March 27 and April 3, the global financial turbulence score fell from 8.03 to 7.70 (a 4% decrease). The decrease in the VIX, the fear index, was much higher. This latter index went down from 46.8 to 41.67 (an 11% decrease). This situation is explained by the rise in the major benchmark indices. On the New York Stock Exchange, the NASDAQ, the Bombay Stock Exchange, the Toronto Stock Exchange, and the Brazil Stock Exchange, the benchmark indices increased by more than 10%.

Figure 1: Global Financial Turbulence Scores and VIX, Jan 8, 2000 - Apr 3, 2020

Oil markets are also suffering severely from the on-going crisis. On March 13, in the heat of the financial turbulence, the spot price of the West Texas Intermediate (WTI) and the Brent fell by 28.9% and 33.5%, respectively. (The WTI and the Brent are both sweet light crude oil serving as benchmark in pricing.) The following week they further declined by 25.3% and 23.9%, respectively. As one can see in Figure 2, the prices of these crude oil keep falling. This price crash is due to thee overproduction of oil and the decrease in its demand after the lockdown of several economies. This situation is affecting not only oil producing firms and the industries depending directly on this activity, but also public finance. In Canada, the provinces of Alberta and Newfoundland and Labrador are the most affected by this unexpected oil price crash.

Weekly Cushing, Oklahoma WTI and Europe Brent Spot Prices, Jan 1, 2000 - Apr 3, 2020

Dataset and Code

The Latest Global Financial Turbulence Scores.

Date	Score
Feb 14, 2020	1.36
Feb 21, 2020	6.23
Feb 28, 2020	3.68
Mar 6, 2020	9.74
Mar 13, 2020	12.89
Mar 20, 2020	9.37
Mar 27, 2020	8.03
Apr 3, 2020	7.70

The components indices of the global financial turbulence score

(1) NYA: the New York Stock Exchange composite index, (2) IXIC: the NASDAQ composite, (3) N225, the Tokyo Stock Exchange average index, (4) FTAS, the London Stock Exchange FTSE all share, (5) HSI, the Hong Kong Stock Exchange index, (6) N150, the Euronext Next 150 index, (7) GSPTSE, the Toronto Stock Exchange composite index, (8) BSESN, the Bombay Stock Exchange sensitive index, (9) GDAXI, the Frankfurt Stock Exchange performance index, (10) AXJO, the Australian Securities Exchange S&P 200, (11) SSMI, the SIX Swiss exchange mid-cap index, and (12) IBOVESPA, the Brazil Stock Exchange index.

Formula

$$d_t² = (r_t - μ ) Σ ^-1 (r_t - μ )',

where $d$ denotes the turbulence score, the vector $r$_t lists the current growth rates of the benchmark indices, the vector $$ μ their historical averages, and $$ Σ designates their variance-covariance matrix. For further details, see Mark Kritzman and Li Yuanzhen (2010).

The impacts of the coronavirus on the global economy: Part IV

Between March 20 and March 27, the global financial turbulence score dropped from 9.4 to 8, which represents a 14.3% decrease. At the same time, the implied volatility index, VIX, also fell from 65.54 to 57.08 (a 12.9% decrease). This means that stock markets across the globe have actually become less volatile and investors have started fearing less about the future. The major stock markets, except Bombay Stock Exchange, are recovering. Could this mean the global financial crisis caused by the outbreak of the COVID-19 is nearing an end? i do not think so and here are the reasons.

First, the levels of the global financial turbulence score and the VIX are still high. As it appears in Figure 1, they are above the red horizontal lines, which represent their expected values during high volatility periods. These expected values are respectively 3.4 and 27.8. Second, most benchmark indices are still, at least, 14% below their levels of February 14, 2020. For example, on May 27, the New York Stock Exchange (NYSE) composite index was 29.3% below its level of February 14, the Next 150 index was 31.6% below, and the Bovespa Index was 38.8% below. Third, stopping the spread of the COVID-19 has necessitated inducing a recession by closing borders and some businesses, which government are not yet ready to reopen.

Figure 1: Global Financial Turbulence Scores and VIX, Jan 8, 2000 - Mar 28, 2020

Are there signs of flight to safety?

Quite often, high uncertainty in financial markets leads investors seeking less risk to prefer government bonds to stocks. The move of investment funds out of stocks into bonds that follows is referred to as flight-to-safety. The current financial crisis has not triggered any flight to safety from stocks to bonds. The reason is that both bond yields and stock prices have been falling. The 13-week treasury bill rate went down from 1.54% on February 14 to .06% on April 2. In these conditions, acquiring bonds does not appear to be a safer alternative investment opportunity.

Figure 2: NYSE Composite Index and the 13-Week Treasury Bill Rate, Feb 14, 2020 - April 2, 2020

Dataset and Code

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The Latest Global Financial Turbulence Scores.

Date	Score
Feb 14, 2020	1.36
Feb 21, 2020	6.23
Feb 28, 2020	3.68
Mar 6, 2020	9.74
Mar 13, 2020	12.89
Mar 20, 2020	9.37
Mar 27, 2020	8.03

The components indices of the global financial turbulence score

(1) NYA: the New York Stock Exchange composite index, (2) IXIC: the NASDAQ composite, (3) N225, the Tokyo Stock Exchange average index, (4) FTAS, the London Stock Exchange FTSE all share, (5) HSI, the Hong Kong Stock Exchange index, (6) N150, the Euronext Next 150 index, (7) GSPTSE, the Toronto Stock Exchange composite index, (8) BSESN, the Bombay Stock Exchange sensitive index, (9) GDAXI, the Frankfurt Stock Exchange performance index, (10) AXJO, the Australian Securities Exchange S&P 200, (11) SSMI, the SIX Swiss exchange mid-cap index, and (12) IBOVESPA, the Brazil Stock Exchange index.

Formula

$$d_t² = (r_t - μ ) Σ ^-1 (r_t - μ )',

where $d$ denotes the turbulence score, the vector $r$_t lists the current growth rates of the benchmark indices, the vector $$ μ their historical averages, and $$ Σ designates their variance-covariance matrix. For further details, see Mark Kritzman and Li Yuanzhen (2010).

The impacts of the coronavirus on the global economy: Part II

On March 11, 2020, the World Health Organization declared the outbreak of the COVID-19 (i.e., the coronavirus disease) a pandemic, which means this epidemic has spread worldwide. Since then, the United States (US) suspended for a month all flights from mainland Europe and declared the state of emergency. Canada closed its borders to foreign nationals, except its permanent residents, diplomats, and US citizens. The European Union also locked down for a month its borders to all non-member countries. Throughout the world, schools and universities are closed, and mass gathering (including religious celebrations) are called off. The various measures taken to put an end to this global health crisis and the panic caused by the situation are affecting the global economy.

On March 9, trading on the New York Stock Exchange (NYSE) paused for 15 minutes, after an initial 7% decline in its benchmark S&P 500. (This halt is the first level of the market-wide circuit breakers, which are a set of three emergency mechanisms aiming at curbing rapid and massive panic selling of securities.) On March 12, the plunge of many benchmark indices reached levels unobserved since the Black Monday (i.e., October 19, 1987). For a second time, trading on both the NYSE and the Toronto Stock Exchange (TSX) paused temporarily, as the S&P 500 and the S&P/TSX composite fell by 9.5% and 12.3%, respectively. On March 16, these two benchmarks respectively fell by 12% and 9.9%, which triggered the first tier of the circuit breakers for the third time in eight days.

To measure the turmoil on stock exchanges, I suggested, in my post The Impacts of the Coronavirus on the Global Economy, the use of the financial turbulence score, which is a multivariate distance measure in standard units proposed by Mark Kritzman and Li Yuanzhen (2010). (In Statistics, the square root of this measure is known as Mahalanobis distance.) I will now be referring to the time series I produced in the above-mentioned post, as global financial turbulence score as it consists of capital gains/losses computed using the benchmark indices of 12 of the 20 largest exchanges in the world. In this post, I update this time series in order to keep following the situation.

The figure below plots the square root of the global financial turbulence weekly time series. Last week, due to the fact that the circuit breaker halted twice stock trading on the NYSE and the TSX, turbulence on the major exchanges was higher than the week before. On March 13, the level of the global financial turbulence score was 12.9, versus 9.7 during the week ending on March 6.

Global Financial Turbulence Scores, Jan 1, 2000 - Mar 14, 2020

Last week, the turbulence score on the major stock exchanges far exceeded 4.3, which is the level expected during high volatility periods. This is the highest score recorded over the reference period.

Many central banks (including the Federal Reserve Bank, the Bank of Canada, and the Bank of England) cut their key interest rates, to stimulate their economies. These emergency measures have not yet succeeded to eliminate panic from financial markets, since the economic activity is still paralyzed by the border restrictions and the imposition of self-isolation (or social distancing). On March 18, the NYSE halted stock trading, for a fourth time in two weeks. As a matter of fact, travel agencies and tour operators, the transportation and warehousing sector, the arts, entertainment and recreation sector, and the accommodation and food services sector are suffering severely from the restrictions imposed to stop the spread of the coronavirus. The stocks of listed companies operating in these sectors will keep losing value as long as investors are not seeing any prospect of profit.

Dataset and Code

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The Latest Global Financial Turbulence Scores.

Date	Score
Feb 14, 2020	1.36
Feb 21, 2020	6.23
Feb 28, 2020	3.68
Mar 6, 2020	9.74
Mar 13, 2020	12.89

The components indices of the global financial turbulence score

(1) NYA: the New York Stock Exchange composite index, (2) IXIC: the NASDAQ composite, (3) N225, the Tokyo Stock Exchange average index, (4) FTAS, the London Stock Exchange FTSE all share, (5) HSI, the Hong Kong Stock Exchange index, (6) N150, the Euronext Next 150 index, (7) GSPTSE, the Toronto Stock Exchange composite index, (8) BSESN, the Bombay Stock Exchange sensitive index, (9) GDAXI, the Frankfurt Stock Exchange performance index, (10) AXJO, the Australian Securities Exchange S&P 200, (11) SSMI, the SIX Swiss exchange mid-cap index, and (12) IBOVESPA, the Brazil Stock Exchange index.

Formula

$$d_t² = (r_t - μ ) Σ ^-1 (r_t - μ )',

where $d$ denotes the turbulence score, the vector $r$_t lists the current growth rates of the benchmark indices, the vector $$ μ their historical averages, and $$ Σ designates their variance-covariance matrix. For further details, see Mark Kritzman and Li Yuanzhen (2010).

The Impacts of the Coronavirus on the Global Economy

The outbreak in December 2019 of the coronavirus disease (COVID-19) is affecting now the global economy. Concerns about this disease, which was first identified in the Chinese province of Hubei, and the measures taken to stop its spread are affecting travel agencies and tour operators, the transportation and warehousing sector, financial markets, the arts, entertainment and recreation sector, and public finance. As a matter of fact, while some businesses and administrations are facing stock shortages as a result of the restrictions on exports from China, the world's factory, other businesses are coping with multiple cancellations of reservations and events. Stock and oil prices are falling. Governments are revising downward the forecasts of their economies' growth and the estimates of their budget revenue. Some commentators are already talking about a recession or worse a depression. How serious is the situation?

In this post, I take a look at the current situation in some major financial markets and compare it to historical data in order to find out if, actually, there are reasons to fear the worst. Figure 1 plots 12 benchmark indices of the following markets: (1) the New York Stock Exchange, (2) the NASDAQ, (3) the Tokyo Stock Exchange, (4) the London Stock Exchange, (5) the Hong Kong Stock Exchange, (6) the Euronext, (7) the Toronto Stock Exchange, (8) the Bombay Stock Exchange, (9) the Frankfurt Stock Exchange, (10) the Australian Securities Exchange, (11) the SIX Swiss exchange, and (12) the Brazil Stock Exchange.

Figure 1: Natural Logarithm of Some Weekly Stock Market Benchmark Indices, Jan 1, 2000 - Mar 7, 2020

How serious is the situation?

It appears clearly in Figure 1 that stock prices have been declining over the past weeks, in all these 12 major exchanges. Particularly, on January 24 and on February 21 of this year, these benchmark indices went down simultaneously, when the markets were closing. To take a measure of the situation using a single summary statistic instead of looking at 12 time series individually, I have computed financial turbulence scores following Mark Kritzman and Li Yuanzhen (2010). This statistics is given by the following relation

$$d_t² = (r_t - μ ) Σ ^-1 (r_t - μ )',

where the vector $r$_t lists the current growth rates of the benchmark indices (the capital gains or losses), the vector $$ μ their historical averages, and $$Σ designates their variance-covariance matrix.

Figure 2 plots the square root of the turbulence score (i.e., $the\; statistic$d_t ) computed using the benchmark indices of the 12 major exchanges listed above. The two horizontal lines on this figure are thresholds defining three regions: (1) in the region below 2.5 (demarcated by the green line), the global financial market is in a quiet state, (2) in the region above 4.1 (demarcated by the red line), the market is very turbulent, (3) in-between, there is an unconditional probability of 82% that the market be in a quiet state. For information, these estimates have been produced fitting a Markov-switching model to the turbulence statistics.

Figure 2: Financial Turbulence Score Based on 12 Major World Indices, Jan 7, 2000 - Mar 7, 2020

The two highest turbulence scores observed since the outbreak of the coronavirus are 6.2 (on February 21) and 9.7 (on March 6). As one could see in Figure 1, this indicates that the global financial market is currently in turbulence. But, contrary to what we were led to think, this only started on February 21. Furthermore, the situation is not comparable to the episodes of turbulence experienced during the burst of the dot-com bubble in the early 2000s, the financial crisis of 2007-08, or the oil crisis of 2015.

What to expect in the coming weeks?

An accurate answer depends on how the COVID-19 will evolve. While encouraging signs are coming from the province of Hubei in China where the virus was first identified, warning signs are coming from Italy where this mortal virus is spreading. Using the historical data, I can predict that there is a very high probability that the current state of the global financial market remain the same in the next 12 weeks. However, this probability decreases progressively going from 88% for the week ending on March 13 to 32% for the week ending on May 29.

Dataset and Code

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The Latest Global Financial Turbulence Scores.

Date	Score
Feb 14, 2020	1.36
Feb 21, 2020	6.23
Feb 28, 2020	3.68
Mar 6, 2020	9.74

The components indices of the global financial turbulence score

(1) NYA: the New York Stock Exchange composite index, (2) IXIC: the NASDAQ composite, (3) N225, the Tokyo Stock Exchange average index, (4) FTAS, the London Stock Exchange FTSE all share, (5) HSI, the Hong Kong Stock Exchange index, (6) N150, the Euronext Next 150 index, (7) GSPTSE, the Toronto Stock Exchange composite index, (8) BSESN, the Bombay Stock Exchange sensitive index, (9) GDAXI, the Frankfurt Stock Exchange performance index, (10) AXJO, the Australian Securities Exchange S&P 200, (11) SSMI, the SIX Swiss exchange mid-cap index, and (12) IBOVESPA, the Brazil Stock Exchange index.