US equities ended the week with a whimper, falling sharply, but Friday’s hangover from a massive three-day surge still left the S&P with a weekly gain of 10%, the best since 2009.
And yet, traders and investors are left with far more questions than answers as they brace for a weekend of dire news around the global public health crisis and look warily ahead to next week, when a raft of key data in the US will likely reflect the hit from shelter-in-place orders and other containment measures in effect across the country.
On Friday evening, just after Donald Trump signed the largest stimulus bill in the nation’s history into law, total COVID-19 infections in the US topped 100,000.
That doesn’t bode well, to say the least.
The narrative right now is that this week’s bounce in equities was a bear market rally. “We are now trading recession”, BofA’s Michael Hartnett said. “3 million surge in unemployment claims [means] the US unemployment rate spikes to 6-7% [and] everyone expects a ‘retest of the lows'”.
Clearly, the possibility exists for a rapid recovery in asset prices given the extent to which positioning/exposure was purged and the prospect that the Fed has managed to preempt any serious (i.e., systemic) credit events. Additionally, USD funding stress is abating globally.
And yet, a recession is a recession, and we’re in one. At least one of Nomura’s updated scenarios is dire indeed. Their base case is hardly what one might call “sanguine” and the “bad scenario” sketched out in the table is rather disconcerting.
“We expect big hits to GDP growth of -43% QoQ SAAR in China in Q1, and in Q2 we expect -42% in the US, -43% in the euro area and -44% in the UK”, the bank says, adding that in a “good scenario”, growth recovers in the second half, inflation remains subdued and the Fed keeps rates at zero through 2021. Here’s a bit more color on the “bad scenario” from Nomura:
Major collateral damage to economies, such as a near double-digit US unemployment rate in 2021. Corporate defaults, bank failures and EM crises become commonplace. DM could face deflation, yet parts of EM face inflation from food shortages. Some central banks are pressured to directly monetize fiscal deficits.
If you ask SocGen’s Sophie Huynh, the range on the S&P in the near-term is likely to be between 1,800 and 2,600.
“We get the S&P 500 at 1,800 in the case of a recession, and we believe that it is the floor in the near term”, she writes, cautioning that the bank doesn’t rule out a scenario where the benchmark falls through that ostensible “floor” in the event “credit stress continues, triggering a domino effect in bankruptcies, with policymakers’ bandage being insufficient”.
Were that “domino effect” to play out, she says “the price-to-book value could be a good anchor”. In that context, the floor is 1,400, “with S&P 500 price-to-book value dipping to 1.52 as in 2007”. To be clear, that would put the S&P down nearly 60% from the highs, and would very likely shake investors’ faith in the viability of US equities as a good long-term investment, even as it would afford the brave an investment opportunity unlikely to be witnessed again for at least a century.
In any event, here’s a summary table of SocGen’s views on the near-term:
Although volatility remains elevated, it should generally come down from here barring another severe shock to investor psychology. As I’ve spent the past week discussing at length, if volatility can sustain a decline, it would have virtuous second-order, knock-on effects.
“Containment of volatility is key for markets from here because unprecedented volatility had created three self-reinforcing negative feedback loops, one between volatility and market liquidity, one between volatility and deleveraging by VaR sensitive investors and another one between volatility and funding markets”, JPMorgan’s Nikolaos Panigirtzoglou reminded clients, in a recent note. “With central banks and governments stepping up their policy responses and attempting to move ahead rather than staying behind the curve, volatility should be contained, breaking [those] loops”.
Speaking of policy responses, late Friday in the US, Dow Jones said the Trump administration is preparing to suspend tariff collections for three months as part of the sweeping effort to prevent further damage to the economy. “Companies would be liable for the tariffs at a later date”, one official said.
Whatever the case, it’s worth taking a step back to marvel at the sheet scope of the stimulus measures undertaken thus far.
“The scale of the policy panic is astonishing”, BofA’s Hartnett said Thursday, in the latest edition of his “Flow Show” series which showed the bank’s “Bull & Bear Indicator” dropping to 0.0.
Hartnett flags 62 rate cuts, $7 trillion of QE, $4-5 trillion of fiscal stimulus and notes that the shift towards yield curve control, universal basic income and Modern Monetary Theory has accelerated.