Market Insights – March 16, 2020

Each week, a team of experts shares its market views with you.

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Pound sterling has become one of the latest coronavirus victims. It lost more than 4% against the euro last week owing to the fears about the economy and to the Bank of England’s unexpected rate cut.

Alternative funds have held up well despite the stock-market correction. Even though they have lost ground, capital protection remains robust, with declines of less than 5% so far this year. This is because these funds are cautiously positioned overall, and leveraging is low.

The confinement measures put in place by the Chinese government to stem the spread of COVID-19 weighed heavily on growth in January and February. Industrial output fell 13.5% and retail sales were down 20.5% year on year. High-frequency data show that activity was exceptionally weak in February – but also that it has gradually started to pick up again in recent weeks. 

Panic-stricken markets

The financial markets had another abysmal week. It’s no longer only stock markets that are affected – all risk assets recorded losses, which is a sign that indiscriminate, panic-driven sell-offs, and even the liquidation of some financial assets, is now widespread. Lower-quality bonds and peripheral and emerging-market currencies also recorded sharp declines. In three weeks, stock-market indexes have lost between 20% and 40% throughout the world. This is an unusual situation, not only because of the extent of the declines but also because of how quickly they have occurred. Yet these losses seem excessive. They suggest that investors are starting to think that the outcome will be worse than a standard global recession. History shows, however, that epidemics have hardly ever brought an economic cycle to an end, as output tends to pick up once the worst of the epidemic has passed. And while this pandemic will cause large-scale economic damage in the short term, growth will probably gain momentum once the outbreak is over. As long as unemployment worldwide does not rise too sharply from current lows, consumer spending should pick up, especially among younger generations, which are much less affected by the virus. The recent market turmoil suggests that panic-stricken investors have lost their long-term vision and are focusing on the immediate problems caused by the epidemic, which is spreading quickly across Europe and the USA. In these circumstances, all eyes are on the authorities and what they will do to try and calm the markets. For the moment, they haven’t managed to reverse the trend. The European Central Bank’s announcement seemed too timid given the challenges that the eurozone economy will have to overcome in the short term. The US Federal Reserve is taking a more aggressive stance. It injected large amounts of liquidity into the system on Thursday and decided to slash rates by an unprecedented 1% over the weekend. Other measures could be announced at its official meeting on Wednesday. The number of interventions is likely to increase. We can expect central banks and governments to work in tandem by combining monetary and fiscal stimulus. These measures should calm the markets and perhaps reverse the trend over the next few weeks. The economy is likely to get going again once the epidemic has passed, so it is reasonable to think that the worst of the correction is now behind us and that we should soon start seizing the resulting investment opportunities.

USA: So what are US stocks actually worth?

The US stock market has plunged even though the coronavirus epidemic is only in the early stages there. This suggests that investors are expecting a severe recession. So is the worst behind us? Is the market starting to stabilise? It’s hard to tell because nobody really yet knows what the actual impact of this crisis will be on the economy and on earnings. Consensus forecasts, which until recently put 2020 EPS growth at 10%, will undoubtedly take a nosedive. But how far will they fall? 10%, 20% or even further? The April earnings season and the inevitable flurry of downward revisions in guidance figures will provide some visibility amidst all the uncertainty – something investors hate more than anything. They will also make it easier to gauge the actual valuation of US stock markets. The S&P 500’s current P/E ratio of 15.5x – which may seem attractive ­­– does not yet reflect the consequences of the measures taken to contain the virus.

If the epidemic starts losing steam and investors begin realising that the current crisis will be short-lived, markets could start pricing in a potential uptick in growth earlier than expected.

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