Market volatility and the coronavirus (April 14 update)

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?

List of key considerations

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:

1. Concrete fiscal measures to help workers and businesses. The 2 trillion USD budget plan – including direct transfers and loans to struggling workers and businesses – is the most ambitious ever proposed in U.S. history. Comparable measures can be found in most developed countries, including Canada.
2. A slowdown in the growth rate of new cases of COVID-19 worldwide. The number of new cases is plateauing in the Eurozone suggesting that the worst is probably behind them. Several encouraging signs are also emerging in the United States where the stability of the number of people testing positive relative to the number of tests administered over the past two weeks indicates the situation is increasingly coming under control. Italy's experience also points to sustained improvement in the coming days. Overall, although the epidemic is obviously not over and the risk of a second wave remains, the growth rate of new cases of COVID-19 worldwide is undeniably slowing.
3. Clearer crude oil supply-and-demand fundamentals. The agreement between the OPEC+ and G20 countries announced over the weekend marks the end of the "price war" and thus, in part, clarifies the fundamentals of oil. However, the uncertainty surrounding the ability/willingness of some countries to meet their commitments, the size of the demand deficit, and limited inventory capacity all suggest that short-term price pressures will remain. In fact, WTI prices remain near their troughs despite recent announcements.
4. The flow of credit to be restored to households and businesses. The series of extraordinary measures announced by the Federal Reserve and recently upgraded to include lower-rated  fixed income securities is a testimony to the central bank whatever-it-takes pledge. Credit and liquidity risk gauges, although naturally higher than in normal times, have consequently eased in recent days.
5. The stock market to consolidate around current levels. Overall, most stock market indices are showing some signs of consolidation. But, the approach of certain moving averages (ma) is an important test for what comes next particularly for the VIX that is sitting on its 50-day ma, and S&P 500 that is likely to get there soon.

The bottom line

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.