April was positive for financial markets, with early signs of a momentum-based recovery from the bottom of the market in late March.
Given the level of market volatility, the extent and speed of the recovery surprised many – it was one of the sharpest and quickest market turnarounds in history. However, the second half of the month was a different story as markets slowed and the recovery seemed to weaken slightly.
We have the Central Banks’ policy stimulus to thank for the ‘relief rally’ so far, with governments continuing to respond with ongoing confidence boosting announcements throughout April. The significant policy support will likely remain in place until governments and Central Banks see robust evidence of a lasting recovery.
But despite the momentum, uncertainty remains high amongst investors. It will probably stay like this until we see significant progress towards lifting social and economic lockdowns across the world’s major economies, and the rate/number of infections reduces across the global population.
It would be unwise to underestimate the scale of the economic impact from COVID-19. Financial markets are already pricing in an economic rebound from the third quarter of this year, but it’s expected to take a few years before we see a return to trend growth across most economies.
- Growth estimates for the second quarter of 2020 across advanced economies are forecast to decline by around 11% year-on-year1.
- Unemployment too is expected to reach a post-war record of 15% in the US and could be as high as 23% in the case of Spain2.
- Policy support initiatives have certainly reduced the likelihood of any further market falls below those levels we experienced in March, but we can’t rule out some movement back towards the previous lows as markets begin to tread water and move sideways with less volatility through the next phase of this crisis.
Evaluating the risk-reward trade-off
With markets recovering some of their significant losses incurred between February and March, investors must now decide whether the risk-reward trade-off is enough for them to confidently invest.
Within equity markets, although the outlook remains uncertain, investors are being rewarded for taking on risk. While earnings expectations for companies have fallen, valuations have increased since the lows seen in March – good news for equity investors.
In the credit markets, credit spreads (the difference in yield between two bonds of similar maturity but different credit quality) have stabilised after previously narrowing quickly. Narrowing credit spreads generally indicate higher conviction in a company’s viability and strength, so credit remains popular and could perform well in the coming months. It’s being fuelled by strong demand, particularly in areas where policy is supportive. For example, Boeing, the US aeronautical manufacturer, recently announced a successful capital raising of US$25bn despite being exposed to an airline industry that’s grounded for the foreseeable future.
The current environment is enabling companies to borrow money at very low levels and when combined with the support offered by governments and Central Banks, it presents plenty of opportunity to help businesses manage their cash flows until the economy fully opens up again.
There’s no doubt COVID-19 brought an abrupt end to one of the longest growth cycles markets have ever experienced. But the extreme shock to economic and market fundamentals has thankfully been largely offset by enormous amounts of policy-driven stimulus supporting the market. Without this, the repercussions could have been far more devastating.
Looking ahead, the future remains unknown and hard to predict. The relaxation of lockdown restrictions may be underway but there’s much talk of a second wave of the pandemic. The degree to which it impacts markets will be driven by the world’s readiness and responsiveness when dealing with the predicted further outbreaks. Lessons have been learned and we will need to use this knowledge wisely in the future.
1 Bloomberg L.P. consensus estimate surveys April
2 Bloomberg L.P. consensus estimate surveys April
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