V for Victory? After plunging into bear market territory in record time (down 34% from February 19 to March 23) the last three weeks saw U.S. equities recoup roughly half of their losses. This spectacular rally was comparable only to the rebound that marked the end of the financial crisis in March 2009.
Undoubtedly, the key factor behind this V-shaped stock market recovery is renewed investor optimism following a succession of unprecedented monetary and fiscal announcements, combined with a deceleration in the spread of the virus. Accordingly, our sentiment indicator exited extreme pessimism levels on April 10 (Chart 3). Question: Is it premature for markets to anticipate an imminent victory in the war against COVID-19?
To determine whether the worst is behind us, for a second time we are revisiting our list of key elements that were introduced on March 18, specifically:
The war against COVID-19 is obviously not over as only the development of a vaccine (unlikely this year) would allow the world to claim victory. However, none of the five key items in our list is flashing red, suggesting that the worst of this historic crisis is behind us. Now, does that mean it's time to increase portfolio risk by shifting their allocations towards equity markets?
Over a longer-term horizon (> 12 months), we continue to believe that the outlook for equities compares favourably to safer bonds. This is what we argued on March 18 when we concluded the current situation represented more of an opportunity than a threat. This is all the more true, now that we have moved away from more dire scenarios. Besides, the equity risk premium remains close to an eight-year high.
In the shorter term (horizon of < 3 months), we continue to lean toward the side of caution. The magnitude and speed will have to pass the test of the upcoming earnings season which should focus, as requested by the Securities and Exchange Commission (SEC), on the current and potential pandemic impact. This may undermine the stock market's apparent hopes for a sharp economic recovery and thus create a better tactical entry point. To be continued.
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