Markets have just been betting that stocks will do what they always do - climb over time. And knocking a third off world equity prices in less than a month appears to have been enough of a discount for many investors to take account of the deep but temporary coronavirus shock.
Whatever shape the recovery proves to be, there’s already willingness among some investors to assume the $10 trillion-plus of government intervention will effectively bridge a chasm in economic output in the second quarter of 2020.
The speed and extent of the bounceback - while clearly still hinging on the trajectory of the virus - is now the central debate.
But as Goldman Sachs’ chief U.S. economist Jan Hatzius pointed out, whether it’s a sharp V-shaped or a more protracted U-shaped rebound sometimes just depends on the stats you’re using.
Goldman’s forecasts for annual gross domestic product rates, preferred by company analysts, point to a “U”, but quarter-on-quarter stats of the macro world show a very angular “V” with “growth rates in H2 that are unprecedented in postwar history”.
“Such is the strange world of recovering from a pandemic shock,” Hatzius added.
Rallying markets have merely latched onto this strange world to price what most expect to be a sharp rebound later this year.
Global stock markets lost a third of their value in just 27 days as the virus shock hit in late February and early March. MSCI’s all-country index has recovered about half of that points loss in the 17 days since it troughed on March 23.
So, not yet a “V”, even if individual stocks that benefit from lockdowns, such as Amazon, WalMart or Netflix - or even parts of the credit market, such as corporate investment grade exchange-traded funds - have almost completed the round trip.
Yet the speed of this unfolding crisis and rescue means we’re still only 44 trading days from the last record high in the MSCI global index and only two weeks into a quarter likely to see the biggest implosion in global GDP on record - in a year forecast by the International Monetary Fund on Tuesday as the worst contraction since the 1930s.
But bear markets typically end when a recession eventually hits, and markets are likely already pricing in a recovery that the IMF expects to record a 5.8% rebound in 2021 - a growth rate almost 2 points above the 20-year average.
That’s clearly not a quick return to normal and few doubt the damage will last at least two years. The IMF stresses the world’s output will likely be a cumulative $9 trillion less over two years than it would have been otherwise, and JPMorgan estimates global profits will still be 20% below the pre-pandemic path by the end of 2021.
But the combined monetary and fiscal support injected already exceeds that estimated lost output and is rising. It will at least hasten the return to growth when the virus allows.
That stocks bounce back, and have risen over time, is clear. They are five times the level they were 33 years ago when MSCI’s global index began. Even after this year’s shakeout, they’re still up 10% from the peaks hit before the last crash 12 years ago and up 36% from the highs set just before the dotcom bust in 2000.
And if markets continue rising over time anyway, then deep drawdowns will always attract investors that assume GDP and earnings growth won’t just flatline forever and governments and central banks can indeed limit the damage in the interim.
Hedge fund manager Stephen Jen of Eurizon SLJ Capital points out that in 15 U.S. recessions over the past century, Wall Street stocks preceded the trough in the economy by about five months.
Acknowledging all forecasts are predicated on “unknowables” such as long-term virus containment and a successful vaccine search, Jen says that for asset prices at least the duration of the recession is more important than the depth. “The primary aim of the massive financial stimulus is to minimize the duration rather than limiting the depth, the latter being ‘man-made’ and self-inflicted,” he said.
Further fuel for the optimists is that so few investors appear to have taken part in the near 25% rally in stocks seen so far.
Bank of America’s latest survey of fund managers showed a majority expect a U-shaped recovery and remain in “peak pessimism” with cash balances of 5.9% - the highest since the 9/11 attacks in 2001.
Of course, what now looks like the makings of a “V” could well turn out to be a “W” amid worries about second waves of the virus, “winter lockdowns” and fears such a prolonged scenario could exhaust government support.
More respondents in BofA’s survey - some 22% - expect that double-dip rather than a straightforward “V”.
Barclays analysts for one think another wave of earnings downgrades is due as full-year consensus is still too optimistic compared with their view of a 30% drop in earnings per share.
But they noted European equities bottomed out 10 months before earnings in 2009 after 80% of downgrades were done.
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