In the last few days, the global and Indian markets have seen unprecedented bouts of volatility. We are less than 3 months into 2020, but several markets around the world are down 25-40 percent from their peak levels this year.
The Nifty itself is down 37 percent from its record high that was registered just over two months back. In fact, the fall over the past few weeks in the world markets has been the fastest ever recorded in history. Besides equities, even other asset classes have not been spared. For instance, yields on corporate bonds have spiked.
The CBOE VIX has surged to historic highs. Commodities have plummeted, with crude and copper prices down a whopping 65 percent and 30 percent, respectively. The Dollar Index has surged to a 3-year high. Even the safe havens, such as gold and US treasuries, have been dumped of late.
The trigger for the panic? The rapid pace at which the Covid-19 pandemic has been spreading around the world over the past few months, threatening to end the longest global economic expansion that has been in place since the 2008 GFC and drag the world economy into a recession.
The outbreak has subsequently crippled the global supply chain and has had a marked negative impact on sensitive sectors such as tourism, transportation, and retail. The outbreak, which started in China late last year, has now moved to several other countries across the world.
In fact, the number of reported cases has been rising exponentially in European countries and in the US. Given that Covid-19 is highly contagious and spreads via air, several countries have been announcing nation-wide lockdowns in order to break the chain of transmission.
In this unprecedented lockdown, stock markets and exchanges around the world have also announced some unprecedented measures. While a few have restricted short selling to arrest the drop in prices, some have closed exchanges altogether.
In India too, authorities over the weekend mulled closing exchanges, but have since clarified that exchanges will function normally. They, however, did announce a few steps to limit the volatility. These included imposing limits on short selling and increasing margins aggressively for both cash and derivatives segment.
While such restrictions may offer a very brief respite (if at all), they are unlikely to put an end to this unprecedented sell-off. Let us talk about why closing stock exchanges until the panic subsides, might not be as beneficial as many believe.
The last major market shutdown that I can recollect now was during the aftermath of the September 2001 attacks on the US. The US markets were shut for a period of 1-week after the 9/11 attack. After they resumed trading, markets continued to be under immense pressure for the next one week, before bottoming out.
There have been brief halts in the world markets post 9/11 as well, such as the US markets remaining closed for a couple of days in October 2012 because of Hurricane Sandy. The most recent that I can remember is the Hong Kong market being shut for a day last year because of a tropical storm.
However, it must be noted that most of the shutdowns in the past have been for a very brief period and were largely due to physical disruptions. The situation that we are in today is a health crisis, which is very difficult to predict how long it will prevail.
Keeping the stock exchanges shut for a prolonged period is unlikely to bring an end to the freefall that we are witnessing in markets at present. Firstly, most of the world markets are interconnected and businesses are increasingly becoming global in nature.
So, if one country closes its markets and if this is not followed by closures of other markets around the world, investors who have put in their money in the market that is now closed would be at a big disadvantage. It would defeat the primary purpose of the market, which is free price discovery. Secondly, if the markets are shut down for, say, 10 days and the Covid-19 pandemic only worsens during this period, the kind of negative reaction when markets resume trading could be very brutal.
This is because no matter how much intervention is done, markets do tend to eventually return to a state of equilibrium and reflect the prevailing demand and supply picture.
Thirdly, let us also think from an investor’s perspective. Would any investor want the markets to remain closed for a prolonged period and have no access to enter/exit trades at a time when some of the other markets, be it equity, commodity, credit, etc. around the world are open and functioning? I highly doubt.
Even if markets were in a freefall, as they are over the past few weeks, investors would want markets to remain open to freely enter and exit trades based on an incoming piece of information and developments.
Fourthly, closing the markets down for a prolonged period can lead to a loss of investor confidence as it sends out a signal that not even financial markets are free from intervention.
As I see, there are more disadvantages than there are advantages of closing a market down for a prolonged period in reaction to the recent global turmoil.
Remember that not even during the 2002 dot com bubble and during the 2008 GFC were the global markets closed. And they did manage to bounce strongly on both the occasions once the crises were behind. So, why close the markets now?
The author is CEO & Co-founder at FYERS.Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.