Feature Stories | Apr 29 2020
Following a halving of peak losses for stock markets here and in the US, analysts weigh up the expected economic shock from here and whether the rebound can be justified.
-Markets looking ahead to recovery
-U-shaped recovery more likely than V
-Earnings recession will determine direction
-Uncertainty reigns over all
By Greg Peel
On February 21, the ASX200 hit a new all-time intraday high at 7197, with China in lockdown in an effort to contain the spread of Covid-19. Up to that point it was assumed it was just a Chinese problem.
Until it became apparent it wasn't. From late February to mid-March, the ASX200 fell -11% to register a "correction". While fear was elevated, it was widely assumed the virus was something that could be overcome fairly quickly, and that share prices would be able to swiftly V-bounce back to their highs. There were clearly bargains to be had.
Pimco calls this the "hope & hedge" phase of the virus-driven bear market. Investors uncertain about what might happen held on to risky assets but hedged, just in case, by buying bonds and gold.
In late March, Australia, too, went into lockdown. No more holding on to risky assets. Sell everything. Pimco calls this the "De-risk, De-lever, Liquify" phase, which took the ASX200 into a "bear market", down -39% by late in the month. Investors were not just selling voluntarily, margin calls came into play. Even gold and bonds were thus sold.
On March 23 a bottom was put in place, and the ASX200 rallied 25% to mid-April, to be down -24% from February. The trigger was massive central bank stimulus, including "whatever it takes" measures from the US Federal Reserve and the Reserve Bank of Australia, followed up by massive fiscal stimulus packages. Pimco calls this the "Opportunistic Offence" phase, with bargain hunting running amok.
The ASX200 has since fallen back around 5300 and appears to be consolidating in what we might call the beginning of a "What Now?" phase.
Adding to hope has been movement towards the lifting of lockdown restrictions. But that may yet prove to be a very slow process.
Meanwhile, economic data shock has begun. To date we've only seen relatively early indications of what the impact will be, and things can only get worse from here as data catches up to the virus, yet the market remains forward-looking, taking weak data in its stride and attempting to anticipate just what the ultimate fallout might be.
It is a given Australia, and the rest of the world, has now fallen into recession. The question is as to how quickly we can come out of it.
V, U, W or L?
An economic "V" shape implies a swift recovery out of what will be an historically shocking June quarter. A "U" implies a slower turnaround into recovery, maybe lingering through to 2021. A "W" implies things might get worse again before they get better, and and an obvious trigger for that would be a feared "second wave" of the virus. An "L" implies things don't get any better for a long time.
In the case of stock markets, we've already had the anticipatory "V". The question is whether this will turn into a "W" on a second leg down, not necessarily because of a second wave of the virus, but because the initial "V" proved to be overly optimistic.
This game of numbers and letters underscores a simple reality. As MFS Investment Management puts it (perhaps with apologies to Donald Rumsfeld), there are "known knowns" and "known unknowns".
It's What You Know
MFS suggests that for the next several weeks investors are unlikely to be surprised by "horrendous" macroeconomic data. Evidence to date backs up that claim. The past four weeks have seen more US workers apply for unemployment benefits than there were jobs created in the entirety of the economic bull market from the 2009 GFC low, yet the US stock market has regained half its losses in that time.
We all know it's going to be bad. This is a "known known". We also appreciate the resultant corporate "earnings recession" will be bad.
What we also otherwise appreciate is that we don't know what the pace of economic recovery will be nor the path of post-recession earnings growth. These are two "known unknowns".
Yet the S&P500, in the face of the worst recession in our lifetimes, has taken equity valuations back to a level last seen only in June last year. (Not so effusive for the ASX200, which is back in 2016.) Over the past few weeks, notes MFS, investors have increasingly assigned a higher probability to a shorter-than-anticipated recession and a stronger acceleration in profits.
Yet another market known unknown is that of earnings dilution as a result of raising new capital. In Australia we have already seen a mad rush in particularly affected sectors, and some not so obviously affected, to bolster capital with new shares. Over the past decade, notes MFS, working capital has been the priority for most US CEOs, and lower balance sheet quality has been the lever. More share buybacks have been implemented in the recent past than any other time in recent history, peaking in 2019.
MFS reminds that 2008, in the heat of the GFC, saw an historically high level of capital raising, leading to substantial shareholder dilution, and this recession is expected to be even deeper.