Skip to Main Content
Go back to Market Insights

Have Global Equities Bottomed?

Celia Dallas

Probably not, unless we experience a V-shaped economic recovery. The sudden stop in economic activity across the globe in response to COVID-19 has triggered an economic collapse and led to an extraordinary monetary and fiscal policy response. Never before have we seen this mix of circumstances, yet markets have moved with unusual speed to price in high odds of a V-shaped economic recovery, with global consensus earnings estimates expected to clear 2019 year-end levels by the end of next year. Progress toward containing COVID-19, together with a fast and forceful policy response, have reduced downside risk to the economy and corporate earnings, thus improving prospects for equities. Yet, even as the economy begins to recover, consumer reluctance/inability to spend, high levels of corporate debt, and constraints on businesses remain key challenges to a V-shaped economic recovery. If the recovery pace disappoints, global equities could hit fresh lows.

After plummeting 32.4%, global equities have now retraced nearly 80% of their losses. Markets recovering from exogenous events often never look back. However, when bear markets are accompanied by recessions, relief rallies are typical before markets ultimately bottom.

For the economy to bounce back sharply, a revival of consumption and capital investment may prove the most challenging. Most large economies are driven by consumption, yet how feasible is it that individuals will rapidly resume normal spending patterns? Even in China, where draconian measures have nearly eliminated the spread of the virus, consumption has continued to contract. Households always slow consumption after recessions to boost savings; this time it is likely to be more pronounced given the scale of the shock.

The flip side of reduced consumption is lower corporate revenues that make it difficult to service high levels of corporate debt. Efforts to contain the spread of COVID-19 triggered the recession, but the global economy’s high nonfinancial corporate debt levels were a pre-existing condition that could allow the recession to continue after the virus fades. Corporate debt levels today are even higher than those that prevailed in 2007 at the start of the Global Financial Crisis.

The wide availability of a vaccine would pave the fastest path to recovery. Several pharmaceutical and biotech firms have made encouraging progress. However, medical experts continue to stress that developing and testing a vaccine and obtaining approval for it in 12 to 18 months would be a remarkable feat. The current record for developing a new vaccine is four years. The good news is that vaccine development is being fast-tracked, and while estimates vary, developers are exploring more than 100 vaccines.

The ability of governments to provide adequate fiscal support is also critical. Thus far, the fiscal support provided by Japan, Australia, the United States, China, and Germany appears to be sufficient to offset the estimated direct and indirect economic contraction stemming from containment efforts. However, outside of Japan and Australia, fiscal support is inadequate to offset estimates of the impact from a second wave of the virus; the United States, China, and Germany are on the cusp. For now, most major economies are pragmatically providing enough support to plug lockdown-created holes, but that may change should the price tag go up, especially if an end to the pandemic remains elusive.

Some strategists put forth the argument that central banks have lowered the discount rate for equities, pushing up their fair value, particularly in the United States where Federal Reserve policies helped lower the risk-free rate and credit spreads. We have some sympathy for this argument, but counter that an extended recovery period for earnings, further shocks that boost the cost of credit, and an increase in the risk premium to compensate for the incremental risk of equity over credit could depress equity values even with low risk-free rates. Monetary policy on its own cannot support the rally in equities in the absence of economic recovery.

Investors should maintain a healthy degree of skepticism about the ability of the global economy and risky assets to manage a V-shaped recovery. While possible, especially if there is a medical breakthrough on a vaccine and/or therapeutics, the burden of proof falls on the optimists. Until there are more positive signs around the ability of both business activity to return to normal and governments to provide adequate policy support for the duration of this pandemic, we maintain neutral positions in risky assets rather than chasing the rally.