A Study on Regime Shift in Stock Market during the Pandemic

The global economy exhibited strong resilience against the COVID-19 pandemic and recovered faster than the general forecast. The Japanese economy also fully recovered within a year following the onset of the pandemic. Japanese life insurers have historically struggled with the impacts of a prolonged low-interest-rate environment. It necessitated increased risk-taking via equity investment to achieve sufficient earnings to cover guaranteed interest rates in liabilities. As a result, they faced a significant decline in (unrealised) capital gains due to market falls at the onset of the pandemic. However, backed by a strong capital base, many life insurers could maintain their strategic asset allocation and were not forced sellers of assets. Fortunately, the stock market soon recovered before severe losses crystallised. This paper has three main sections: First, we review the impact of the pandemic’s onset on global stock markets. We study the behaviour of volatility indices VIX, NKvi,VSTOXX, and we examine the stock index changes of S&P, TOPIX, STOXX, looking at 30-day moving statistics. Finally, we identify four typical regimes for the studied indices: Turmoil, Bottoming, Recovery, and Stability. Secondly, we examine the behaviour of the Japanese stock market in some detail. Following a comprehensive review of the market’s composition, we focus on selected leading sectors. We group these sectors into four categories characterised by their different resistance and recovery attributes. Third, we present a case study wherein we show that a combination of a collar hedging strategy and simple portfolio sector reallocation of strategic stock holdings can achieve an enhanced risk-return profile through improved diversification properties. And in our conclusion, we note that examining past market behaviour throughout the crisis provides valuable insight for informing insurers’ actions in the next pandemic.

Find the Q&A here: Q&A on 'Macro Issues Affecting Financial Markets'