Darius Svidleras
Investment Portfolio Manager

After extraordinary market decline, triggered by coronavirus economic shutdowns, prices of global equities and majority of other risky assets bottomed in late March and continued drifting upwards throughout April, rising from bottom by almost 30%. There were two major reasons supporting strong rally – improvement in coronavirus dynamics and monetary stimuli announced and implemented.

Indeed, number of new daily global and US COVID‑19 cases stopped accelerating further and reached plateau at the start of the month. Moreover, in most severely hit Western European countries such as Italy and Spain spread of disease was in clear downtrend compared to March. As a result, it allowed to lift some of the quarantine measures by the end of April, and in some countries such as Germany even reopen parts of the economy. In USA, states were also allowed to decide, if to reopen their economy starting from 1st of May. 

Daily increase in global, US, Spain and Italy coronavirus cases


Source: Bloomberg

Furthermore, global central banks continued to introduce additional measures in order to ease potential economic damages, with FED this time being particularly active. Specifically, US Central bank announced that it will start buying not just government securities, but also corporate bonds and bond ETFs, with possibility to buy funds that hold riskiest high yield debt instruments. In addition, it rolled out $ 2.3 trillion programs to support small and mid‑sized businesses as well as local governments. Together with previously announced measures, FED liquidity injections into financial markets are truly massive in last two months, being already much higher than what was introduced during 2008‑2009 financial recession, and being equivalent in size to all quantitative easing programs undertaken since then.

FED balance sheet


Source: Bloomberg

Such developments boosted investor confidence and led many analysts to believe that bear market is already over, while equity prices being headed to new all‑time highs and potentially much higher levels. However, in our view, unfortunately, this may turn out to be wishful thinking. Economic risks still remain extremely high, and possibility of another leg down to even lower levels than reached in late March still very possible. Let us discuss these risks in more detail.

First of all, it is true that significant progress was made in terms of COVID‑19 dynamics. However, it is quite natural that if majority of population is restricted from contacting each other and predominantly stays at home, no new infectious cases would be registered. However, now, when economies starting to be reopened and inhabitants are allowed to move more freely, could there be any guarantee that acceleration of new virus cases would not return again? “Spanish flu” pandemic of 1918 developed in four waves, and actually it was not the first, but second wave which turned out to be most infectious and deadliest. Nobody knows, will there be and if it does, how severe can be the second wave in COVID‑19, but we think it should be quite explanatory what is likely to happen to global economy, if another round of economic shutdowns and quarantine measures will have to be reintroduced. In this scenario, if markets realize that another wave of pandemic is coming, decline in equities may turn out to be even more rapid than what was observed in March.

Secondly, even, if from virus perspective, the worst is over, according to IMF, global economy is still likely to be headed for worst economic downturn since the Great Depression. Different macroeconomic indicators in various countries are hitting record low numbers. For example, since end of February US continuous unemployment claims went from less than 2 million to around 20 million, indicating that unemployment rate is already above 15% in USA right now. Thus, just in around one month number of jobs being lost equaled to number of all new jobs being created since the end of last recession in mid‑2009.

USA Continuous unemployment claims


Source: Bloomberg

Just as in any recession, it is quite logical to assume that even despite all introduced stimulus measures, least effective and most leveraged companies would still be going out of business, while it would take considerable time to reemploy all people who lost their job. As a result, it may lead to prolonged negative impact on consumption and investment levels, which would lower aggregate economic demand, unless it is fully replaced by government spending. In addition, it is unclear, if recent events modified established spending patterns – after pandemic population and corporations may increase their propensity to save, leading to another negative impact to GDP. All these actions are likely to lower corporate earnings further in the upcoming quarters and put additional pressure on prices of financial assets. Another risk that we cannot ignore right now. 

US consumer confidence vs S&P‑500​


Source: Bloomberg

US personal saving as % of disposable income


Source: Bloomberg

Third, even if all optimistic scenarios will play out, and corporate earnings are not reduced more than is already expected, equities are not being cheap right now. According to forward price to earnings multiples; valuation of global equities as measured by MSCI ACWI is highest since at least 2003. Given extraordinary uncertainty about the future that we are witnessing at the moment, and the fact that majority of corporations are refusing to give any forward looking guidance, because even to management executives it is highly unclear what would be their upcoming financial results, such valuations may be way too optimistic.

Forward P/E multiple of MSCI ACWI (global equity index)


Source: Bloomberg

Also, we may say that despite April rally being extremely strong, it is not abnormal given magnitude of initial decline from late February. Often during recessions, after first initial shock lower, investors still believe that large declines in asset prices may be prevented, as economy will be fast enough to recover. As a result, prices experience strong rebound, until more bleak reality resurfaces.  It happened in 2008, when housing crisis was already common knowledge and multiple banks including Bear Sterns were already bailed out. It happened in 2000, when dot‑com bubble has already burst and multiple internet companies were facing financial trouble. It also happened after1929 Wall Street Crash to which we compared 2020 decline in terms of magnitude in our previous overview. After initial crash lower at that time, US indices rebounded by around 50% higher before continuing significant decline.  Please note that we are not saying something similar should happen this time, but we cannot ignore the risk of further market decline.

Percentage of price recovered in rebound after initial move down during recessions


Source: Bloomberg

Summing up, despite some positive encouraging news and good rebound in financial markets, significant risks described above remain. However, there is also some balancing effect from all the monetary and fiscal stimulus implemented and announced. For example, although earnings yield (earnings divided by price) is fairly low right now, compared to close to 0% bond yields, equities do still offer some risk premium. Nevertheless, uncertainty remains high as there are still many unknowns. Therefore, it makes sense to stay cautious and stick to your long‑term plan avoiding impulsive investment decisions based on market price actions.

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