Since my last post there has been an even bigger onslaught of fiscal and monetary stimulus measures globally in an attempt to combat the devasting health and economic impact of COVID-19. Fiscal stimulus in the US will amount to over 10% of GDP while the Federal Reserve’s balance sheet is set to grow further from an already large $6+ trillion at present as the Fed throws everything but the kitchen sink to combat the impact of the virus. There is already preparations underway for another phase of fiscal stimulus in the US.
Europe meanwhile, has struggled to agree upon a package given divisions between the North and South of the region, but eventually agreed upon EUR 500bn worth of fiscal stimulus while the ECB is undertaking renewed asset purchases in a new quantitative easing programme. Many other countries have stepped up their efforts too. All of this will provide an invaluable cushion, but will not prevent a massive economic downturn, nor will it stop the virus from spreading.
Markets have attempted to look past the growing economic risks, spurred by data showing that in many countries the rate of growth of coronavirus cases has slowed, including in those with a substantial number of deaths such as Italy and Spain. Even in New York, which has been the epicentre of COVID-19 infections in the US, there are positive signs though it is an ominous sign that the US has now recorded the most deaths globally.
This move towards flattening of the curve has fuelled hopes that many countries will soon be able to emerge from lock downs. In China, which was first in, most of the manufacturing sector has opened up, while there has even been some relaxation of measures to constrain movement of people. The net result of all of the above last week, was the biggest weekly rally in US stocks since 1974.
While the 25%+ rally in US equities since their lows is reflecting this optimism, there is a major risk that this is a bear market rally given the risks ahead. Economic growth estimates continue to be revised lower and the IMF’s revised forecasts scheduled to be published this week are likely to show a global economy on the rails, with growth likely to be at its worst since the Great Depression according to the IMF’s Managing Director. Emerging markets, which do not have anywhere near the firepower or health systems of developed economies are particularly at risk.
At the same time earnings expectations have yet to reflect the massively negative impact on corporate profits likely in the months ahead; Q1 earnings to be released in the days ahead will be closely watched. Not only are earnings expectations likely to be revised substantially lower, but many companies will simply not survive and many of those that do could end up in state hands if they are important enough. Separately there is a risk that shutdowns last longer than expected or once economies begin to open up there another wave of infections. These risk have not yet been fully appreciated by markets unfortunately.