Strange days indeed. The third wave of the crisis is happening as predicted as the virus slams into Latin America – with the awful death toll rising in Brazil – and yet the US market scales new heights. The first chart below – from Sharepad – shows the S&P 500 with the 20 (red) and 200 (blue) day moving average super imposed along with the trend line. Any break above 3000 will out the benchmark US index firmly in bullish territory, helped along by significant increases in market turnover (the bar charts at the bottom). In essence, US equities are now roughly back where they were mid summer 2019.
The S&P 500
But not every market has bounced back so aggressively. The second chart below is for the FTSE 250 and shows that the UK mid cap index is only just getting back to levels last seen in 2016 and at the end of 2018. Crucially it is still trading well below the 200 day MA and my guess is that we won’t see this level until we move above 18500, which implies another 10% uplift from here.
The FTSE 250
Overall, my guess is that the US market in particular has now in effect priced in a V shaped recovery whereas the UK market is valued closer to a U-shaped recovery. One of those may be right but my money is still on a W shaped recovery.
My stab in the dark at US equities pricing in a V shaped rebound is echoed in a short piece out this week called Four COVID-19 Scenarios: What Might Happen Next? by MSCI analysts Thomas Verbraken and Juan Sampieri. They’ve used their own proprietary model to extrapolate four potential market outcomes using IMF scenarios, all done using May 19th data. The various modelled rebounds consist of ones that are V shaped, U shaped, swoosh (closest to my W) and L. The MSCI analysts reckon a V shaped scenario assumes an annualized 2.15-percentage-point contraction in the U.S. economy over the next two years but no persistent impact.
“On the other end of the spectrum is a pessimistic L-shaped scenario in which outbreaks and lock downs occur well into 2021; this scenario assumes not only a severe short-term contraction, but persistent effects — with annualized growth five years from now 1.6 percentage points lower than the pre-COVID baseline. “ The chart below maps out these various scenarios and their real output impact.
The Market Impact of Short- and Long-Term Growth Shocks
These macro numbers are then fed back into an MSCI macro economic model which throws out equity losses that vary between -13% and -45% compared to the pre crisis peak.
Macroeconomic and market scenario assumptions
|Scenario (shocks relative to Feb. 19, 2020)||V-shaped||U-shaped||Swoosh-shaped||L-shaped|
|Annualized two-year growth shock||-2.15%||-3.15%||-4.55%||-6.25%|
|Annualized long-term growth shock||+0.00%||-0.40%||-1.00%||-1.60%|
|10-year Treasury real rate (level)||-0.15%||-0.20%||-0.30%||-0.40%|
|Implied equity returns (%)||–13%||–22%||-33%||-45%|
|10-year Treasury yield (level)||1.20%||0.90%||0.70%||0.50%|
|10-year Bund yield (level)||-0.30%||-0.50%||-0.70%||-0.90%|
|10-year Italian sovereign yield (level)||1.40%||1.70%||2.30%||3.50%|
|US IG bond spread shock (bps)||+120bps||+200bps||+310bps||+420bps|
|US HY bond spread shock (bps)||+255bps||+440bps||+685bps||+925bps|
|Oil Price (level)||$45||$35||$25||$20|
|Implied inflation (level)||1.35%||1.10%||1.00%||0.85%|
Using this model, the MSCI analysts reckon the current market level almost exactly mirrors the V shaped scenario whereas the original market low in March hinted at a swoosh shaped scenario. These numbers are then, lastly, fed back into a portfolio modelling tool , using a hypothetical 60/40 portfolio of equities and bonds which then indicates “ that such a portfolio could slightly gain under our V-shaped scenario or lose a further 24% under our L-shaped scenario”. I’d also observe on a side note that the inflation expectations for a V shaped recovery – of 1.35% – look a tad on the low side to me.
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