Stock market shutdowns may cause long-lasting damage

The debate over whether to shut down market trading has intensified over the past week, with lawmakers in the US calling for a pause, while industry bodies in India have called for a complete shutdown in exchanges, in response to the coronavirus crisis. Some shutdowns are systematic and temporary (e.g. circuit breakers in diverse markets Brazil, US, Kuwait, and Pakistan), but others are adhoc (Sri Lanka) or indefinite (Jordan, Philippines) and these may well cause long-lasting damage because they blur a vain attempt to stall market falls with a valid social distancing policy response to coronavirus.

Across emerging and frontier markets, the more that the authorities can avoid stock (or debt, or currency) market shutdown, the better they will be served once the coronavirus crisis passes and there is inevitably an even greater need for external capital inflow.

And if stock market shutdowns are an unavoidable consequence of the physical social distancing policy response to coronavirus, then they should be communicated as such, with defined (albeit obviously adjustable) end dates.

The worst outcome is to use the coronavirus as a reactive justification for halting a falling market, even though the market may be falling very rationally and very rapidly in response to the risks and disruption caused by the coronavirus.

Stock market shutdowns are not new

China shut its stock market for a week after the Lunar New Year this year (when Covid-19 was still being called the “Wuhan Coronavirus”). The New York stock exchange shut its stock market in 1997 during the “Asian crisis”, in 2001 after the 9/11 attacks and in 2012 (Storm Sandy). Pakistan effectively shut (inhibiting transactions below prevailing share prices) in 2008-09 in reaction to the global financial and local political crisis. Egypt shut in 2011 (“Arab Spring”). These are but a few examples.

Adhoc or indefinite shutdowns (Jordan, Philippines and Sri Lanka)

However, the adhoc (Sri Lanka) or indefinite (Jordan, Philippines) stock market shutdowns we are witnessing blur two objectives:

(1) Maintain market order during an extreme swing (and limit systematic repercussions across the financial system and the spread of panic to corporate and consumer confidence); and

(2) Impose a universal physical quarantine in response to the coronavirus.

The first objective of addressing panic is ultimately self-defeating if the shutdown lasts for anything longer than the typical 15-45 minutes of a circuit-breaker; it compounds panic, can make the ultimate fall in stock market value even greater, raises the risk associated with transacting on that market in future, and can lead to a permanent exit of capital.

An exception might be made if during the time of the shutdown a specific set of new government policies are announced e.g. liquidity injection, fiscal stimulus, security or healthcare response, which changes a scenario of market panic to one where there is now sufficient information for investors to price assets rationally.

The second objective of social distancing is partially obsolete in modern stock markets, which rely mainly on electronic platforms. Stock markets such as Jordan, Philippines and Sri Lanka are classified as frontier or emerging markets because they lack some of the market processes and mechanisms, corporate disclosure, or trading liquidity standards associated with developed markets. They are not “frontier” in the nature of, for example, Myanmar, which is heavily reliant on the staff sitting in the stock exchange building to execute a limited number of trades. Nevertheless, it is fair to say that none of these markets could operate if there was literally nobody allowed into the stock exchange premise.

Now, if these markets were shut in the same breath and on the same time frame as universal lock-downs of that location (e.g. Manila and the whole of Luzon island in the Philippines), there would be more understanding of a natural disaster-type reason for the market shut-down (similar to Storm Sandy in the US in 2012).

But what we are seeing in the likes of Jordan, Philippines and Sri Lanka neither meets the description given above for the exceptional justification for closing stock markets (there is no silver bullet policy announcement), nor is this simply about a healthcare response to the coronavirus (otherwise the stock market would be shut, from day one, for as long as the overall physical lockdown).

There is a blurring of both objectives defined above and this creates the suspicion that the coronavirus is being used as a justification for halting a falling market, even though such falls have been rational.

Hasnain Malik is the Managing Director for Emerging & Frontier Markets Equity Strategy at Tellimer. He covers about 35 emerging and frontier markets globally, mixing valuation, currency risk, economic growth or reform, and domestic and geopolitical risk to determine which of those markets are attractive.