A rebound after the crash

Historical volatility

Between its record high on 19 February and its low on 23 March, the S&P500 index plummeted by 34%, before gaining 18% over the subsequent three days. Volatility on the EuroStoxx50 was even sharper: -38% between 19/02 and 18/03, followed by a 19% rebound. This recovery came on the back of the massive stimulus packages decided by authorities and central banks, people returning to work in China, and the realisation that the stock market crash was perhaps overdone.

The uncontrollable spread of the Coronavirus in the US fuelled doubts in the markets on Friday, leading to stocks shedding some of their gains. The S&P500 index closed the week up 10%, and the European stock markets up 7%.

Two weeks ago, bond yields had started to increase on concerns about rising budget deficits and defaults on corporate debt. However, the massive bond buying programmes announced by central banks have pushed down bond yields again, even in southern European countries.

The impact on the economy will be worse than expected …

Economists estimate that the current lock-down measures are slowing down economic activity by between 30-40%. If this situation persists for six weeks before getting back to normal, the contraction for the full year 2020 will exceed 5%, an unprecedented level.  In other words, this recession will be even worse than that of 2008-2009, when the European economy shrunk by 4.5%. The first signs are already visible: business and consumer confidence are plunging, jobless claims in the United States are soaring, and so on. 

... but authorities and central banks are pulling out all the stops

However, there are also differences compared with the 2008-2009 recession. Back then, the crisis was caused by excessive corporate and bank debt leverage, combined with a sudden fall in house prices that had previously posted an exponential rise. In other words, the markets had caused the crisis themselves.

This time we are faced with an external cause for which no-one can be held responsible. As a result, authorities, central banks and banks are much more forgiving than they were a decade ago, as seen in the speed and scale of the announced support measures.

The US authorities approved a $2,000 billion stimulus package (10% of GDP) consisting of income replacement, medical assistance and tax cuts. And unlike in 2008, when the collapse of Lehman Brothers had snowballed, this time the authorities are willing to keep beleaguered companies afloat. 

The soaring US budget deficit (from 4% to 14% of GDP) and the explosion of government debt are concerns for the future as long as the Federal Reserve continues to finance them.  Apart from the recent rate cut, which is the fastest in history (-1.5% in two weeks), the Fed plans to buy colossal amounts of bonds and credit, a much larger quantity than during the 2008-2009 financial crisis. With this massive injection, banks will not run out of cash this time and will be able to continue lending or even consider repayment deferrals. Banks' solvency has also improved substantially compared with the last crisis.

Companies are withdrawing (or cancelling) their annual forecasts, share buybacks and/or dividend payments

Most companies are withdrawing their previous earnings growth guidance.  Some are reacting by temporarily closing their factories and making drastic cost cuts, or implementing temporary unemployment measures, etc. In addition they are trying to preserve their liquidity by deferring investments, drawing on available credit lines, suspending share buyback programmes and/or trimming or cancelling their dividend payouts. It is already clear that instead of the 10% earnings growth forecasts that analysts were initially expecting, 2020 will see a substantial drop in earnings, even though most affected companies are already seeing their figures in the red.

Let's forget 2020 and focus our attention on 2021

2020 is a lost year, and it would make no sense to assess companies on the basis of today's exceptionally negative context.  For analysts and investors, the most sensible reaction is to anticipate the normalisation that lies ahead in 2021, although we are aware that it will probably not be a full recovery. Indeed, the side effects of rising unemployment and the destabilisation of public finances need to be taken into account. 

As previously mentioned, the markets usually anticipate and generally reach a low when uncertainty is at its highest.  Virologists believe that the epidemic is likely to peak in Europe around the beginning of April. In the United States, on the other hand, we likely expect the situation to worsen initially because lock-down measures were implemented later.  

We therefore take into account two additional weeks of extreme volatility, during which the previous lows could potentially be tested. From a longer time perspective, however, we remain convinced that this presents historical buy opportunities. It is very likely that before the end of April the markets will start to anticipate the end of the lock-down period and a gradual economic recovery from May. Major catalysts in this context could be a flattening of the contamination curve (as observed in China) or a possible breakthrough with a therapy or vaccine.