The S&P 500 lost one-third of its value between its record high on Feb. 19 and March 23. It has clawed back half of that as the Fed chucked out its rule book and went on a shopping spree for assets. Equities are pretty much the only type of security that it won’t be adding to its ballooning balance sheet, although a fresh bout of market mayhem might change that too. America’s central bank is already snapping up exchange-traded funds and junk bonds, after all.
A 27% recovery in equities is surprising given that we still have no idea of the virus’s lasting impact on economic output, with only a very partial return to business activity planned and no vaccine in sight. The surge in jobless claims and companies furloughing staff makes forecasting more art than science, much like Covid-19 statistics. As Torsten Slok, Deutsche Bank AG’s chief economist, points out, a decade of U.S. employment gains have been reversed in a month. The International Monetary Fund’s global economic predictions this week were the bleakest since the 1930s.
The monetary and fiscal response has been spectacular but can it prevent a permanent loss of growth if people’s consumption, travel and working practices have been altered fundamentally? A wave of defaults, credit downgrades into junk territory, bankruptcies and price drops in real assets such as aircraft and property would change the more positive stock market narrative quickly, as would a second wave of the virus. Parts of the world, Europe in particular, were at risk of recession before the outbreak. Crude oil prices below $20 per barrel don’t suggest global demand will come roaring back.
The equity market is meant to reflect anticipated corporate earnings, and although it’s often given to wild optimism, this is an entirely new situation. How can anyone say with a straight face that they can estimate future earnings right now? There’s little point scouring through first-quarter results apart from looking at how much provisioning the banks are putting in place for loan losses and how much credit has been drawn down.
Any crisis throws up winners — Amazon.com Inc (NASDAQ:AMZN). shares have hit new highs — but most companies are losing. More than half of workers are employed by small- and medium-sized enterprises, which will struggle to get all the financial assistance on offer.
The latest Fed stimulus package adds another $2.3 trillion of support and from this week corporates can go directly to the central bank for commercial paper funding. The ability of the Fed to really sustain stock prices is going to be tested like never before. More stimulus is always being promised but after a decade of quantitative easing, there will be a limit to its effectiveness.
Catastrophe has been avoided but most of the emergency measures are geared toward liquidity and borrowing costs. Growth is the thing that matters most for equity valuations in the medium term, and no one can guarantee that.
Consumers will only return to familiar spending habits if they have regular income and governments don’t raise taxes to pay for the current splurge. More dividends will be cut or cancelled. The hit to earnings will only be partially recoverable as most consumption is immediate and large items such as cars and electrical goods can be put off for other years.
Equity markets are betting big on the lasting results of all the stimulus. A swifter end to lockdowns or a promising vaccine development would be something to get excited about. Until we have that, the confidence looks overdone.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.