2020 Midyear Market Outlook: The Road to Recovery
Although the coronavirus pandemic delivered a staggering blow to the global economy, equity and credit markets rallied dramatically in the second quarter through mid‑June. The central issue now is whether those rallies have gotten ahead of themselves, Sharps says.
“Anytime you’re in an economic downturn, there comes a point where markets begin to anticipate improvement,” Sharps notes. “Given that the spread of the virus appears to have slowed and many businesses are reopening, I’m not too surprised that markets are off their lows.”
Recent signs that U.S. employment is bouncing back more rapidly than expected as the economy gradually recovers are a significant “green shoot” that has pushed yields on 10‑ and 30‑year Treasury bonds modestly higher, Vaselkiv notes.
…I do think the second quarter will prove to have been the most challenging for economic activity and earnings.
— Robert W. Sharps, Group CIO and Head of Investments
That said, the near‑term earnings outlook remains grim. While consensus forecasts at the start of the year anticipated global economic growth of around 3%, current estimates see a 3% decline for the year, Thomson says. Taking operating leverage into account, that could produce a 50% to 60% aggregate decline in corporate profits.
“We’re still very early in the recovery,” Sharps warns, “but I do think the second quarter will prove to have been the most challenging for economic activity and earnings.”
The key question, Sharps says, is how long it will take for companies to regain enough earnings power to justify current valuation levels while compensating investors for the risk that an economic recovery might not progress as rapidly or evenly as expected.
Global Economic Stimulus to Fight COVID‑19 Impact
(Fig. 1) Percent of Gross Domestic Product
January 31 through May 31, 2020
Sources: Cornerstone Macro, used with permission. Additional T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved.
Stimulus Can Only Do So Much
To a large extent, the rally in risk assets has been driven by massive doses of fiscal and monetary stimulus, which have been even larger than during the 2008–2009 global financial crisis. This, Thomson says, has set the stage for a tug of war between ample liquidity and the collapse in earnings. Further market volatility could result, he cautions.
While fiscal and monetary stimulus have bolstered global markets, there are limits to what governments can do to sustain the recovery:
- In the U.S., a significant portion of the stimulus funds sent directly to low‑ and moderate‑income Americans in April appear to have gone into savings, Vaselkiv says. This could hinder a recovery in consumer spending, which typically accounts for roughly 70% of U.S. gross domestic product (GDP).
- Although French President Emmanuel Macron and German Chancellor Angela Merkel have proposed a European recovery fund to finance EU‑wide fiscal stimulus, unanimous agreement among the EU’s member nations will be required to implement it, Thomson notes.
- Many emerging market countries don’t have the economic and financial strength to undertake massive fiscal stimulus, Thomson adds.
With much of the anticipated benefits of stimulus already priced into risk assets, economic fundamentals will have to take over for broad markets to move higher, Sharps says. “I think the going will be tougher from here.”
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