Revisiting our observations
A month ago, we outlined four factors which may enable a floor to be reached for equity markets. These were:
- Aggressive policy action in the form of both monetary and fiscal measures
- Valuations pricing in a substantial downturn in corporate earnings
- Peaking volatility – which tends to precede a market trough
- Peaking in Covid-19 infection rates
In each case, we have seen substantial progress and, in a number of instances, the newsflow has (positively) surpassed expectations.
Certainly, not only the cuts in interest rates but also the sheer scale and breadth of asset purchase programmes, particularly from the US Federal Reserve, have been a positive surprise. Furthermore, the extent of measures to underwrite both credit and wage risk in the global economy have also been taken positively.
On valuations, markets have bounced back very strongly but, at the lows, they were arguably (and rightly) pricing in a reasonable recession. They are now pricing in a return to growth, certainly for 2021.
Volatility remains high by historic standards but has declined. As markets fell sharply and volatility spiked, certain investors were compelled to de-risk, creating a downward spiral in prices. The risk of a disorderly meltdown has receded and markets are, for the time being, demonstrating both relative resilience and calm.
While the human cost of the Covid-19 outbreak continues to be terrible, there are encouraging signs that infection rates are peaking and that lockdown measures are working. Furthermore, while we remain a long way from normalcy in our daily lives, the discussion has moved towards how and when economies can start to re-open. Indeed, next month it is likely that many major economies will tentatively start on this path. In addition, over 80 potential vaccines have now been identified and a number are currently undergoing trials, raising hopes that, alongside more effective treatment options, a medical solution may soon be identified (even though it would take quite some time to become widely available).
The reality of the downturn sets in
Having had incrementally positive newsflow over the past month, markets now face the uneasy prospect of dealing with the reality of the downturn. Macro indicators, including from the labour market, are now corroborating why economists’ estimates suggested that developed economies may show double-digit declines in GDP over the course of the second quarter. Furthermore, corporates are withdrawing earnings guidance and reporting huge hits to revenue and profits, alongside widespread suspension or cessation of dividends and buybacks. While markets have so far remained relatively impassive in the face of the onslaught of negative reports, this may well become more challenging in the near term as the scale of economic and corporate destruction is laid bare. Expectations have adjusted sharply; reality may well still bite.