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Gauging the depths of the descent

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Markets, anticipating confirmation of a vast US stimulus deal, triggered a whipsaw trading pattern across equities, before Europe closed higher and Wall Street extended its rebound before trimming gains towards the end of trading on Wednesday.

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The combination of the fastest bear market in history and aggressive stimulus has duly shifted the investor conversation towards anticipating a recovery and tempered fears that new lows beckon for equity and credit values in the next few weeks. Supporting this nascent pulse of optimism is a sense that the worst of the forced selling in equities and credit is behind us.

Fiscal and monetary stimulus surely matters but it cannot provide the all-clear signal required by investors — just take a peek at the rising number of virus cases in Europe and North America. And liquidity issues and market dislocations still prevail across the financial landscape, although there are welcome signs of less impairment. 

Equity sentiment leans towards optimism at the best of times, whereas bond markets are focused on the return of capital. In the case of corporate credit, uncertainty over the future path of rating downgrades, restructurings and bankruptcies understandably casts a lengthy shadow across the financial system. This is why equity market crashes are merely the starting point for a much longer process of assessing the final costs, as seen in 2008 and 2001. 

Yes, central banks are expanding their presence in bond markets and governments are in “wartime” borrowing mode, but fundamental pain beckons in the real economy and stands to severely test market sentiment for a while yet. The release of weekly US jobless claims on Thursday will not paint a pretty picture.

All the hopeful talk of markets finding a bottom soon must be weighed against the uncertainty that shrouds the extent of the pandemic and the damage it ultimately inflicts on the economy. Many of us would certainly welcome a return to normality by Easter, yet this appears quixotic, alongside the hope that equity and credit markets have seen their lows.

Oliver Blackbourn at Janus Henderson Investors reckons:

“Investors need to remain vigilant about how the growth rate of new cases develops and how governments respond going forward. While policy looks to have lessened the economic pain, only better health data can make it go away.”

It’s worth remembering that ferocious bear market rallies are a feature of big shocks. This week’s bounce back in share prices is only bettered by the massive rebounds seen in the wake of the 1929 Great Crash. That’s not really a heartwarming message.

Elia Lattuga at UniCredit Bank in London observes:

“When declines of over 25 per cent occurred in the S&P 500 in the past, the negative trend lasted for three months to over one year before a bottom was reached, and such declines often also involved several steps downward following shortlived bear-market rallies.”

A calmer market tone requires meaningful declines in the US dollar, credit-risk premiums and the current elevated measures of market volatility. And beyond all the policy initiatives, AJ Bell’s Russ Mould reminds us:

“What we really need to see are signals that the containment measures introduced by many countries are proving effective at stalling the spread of the coronavirus and evidence that China’s exit strategy from its own lockdown is working.”

Indeed, the recent pattern of big daily swings in equities lines up well with the aftermath of the Lehman Brothers bankruptcy in 2008, as shown here via AJ Bell:

Now those with cash and plenty of patience are no doubt assessing the risk-versus-reward relationship in buying beaten-down shares and sectors across the board.

In that vein, BCA Research says investors with “a higher risk tolerance” and “a nine to 12-month investment horizon” should in its view “start nibbling away at the broad equity market”.

Colin Moore at Columbia Threadneedle Investments says:

“For those who believe economic disruption will be relatively shortlived, as I do, opportunity is being created in financial markets. I see the possibility of 20 per cent upside, or more, 12 months from now.”

Bargain hunters may well wait a little longer and gauge just how sustainable the recent market rally looks before diving in. No one likes being suckered into a bear market rally. 

The global economy is bracing for recession. What questions do you have about the impact of the coronavirus in the global market? US markets editor Jenn Ablan will be taking your questions in our Reddit AMA on Friday at 11am EST. Join us in r/iAMA.

Quick Hits — What’s on the market’s radar

When rating agencies deliver bad news the reaction tends to speak for itself. SoftBank is very unhappy after a two-notch downgrade deeper in junk territory from Moody’s. When the tide washes out, you do see who has been swimming naked and SoftBank is very much on display. At least SoftBank won’t be alone in this regard. 

Bond market measures of future inflation have fallen appreciably, although this area of fixed income has long been known for a lack of liquidity. (In the US Tips market there is another term for Treasury inflation protected securities used by traders.)

While that may skew the outlook to some degree there is quite a debate over whether vast amounts of fiscal stimulus and greater bond buying from central banks stem not just deflationary headwinds, but eventually push consumer prices a lot higher. Here’s the FT Markets look at the investor debate and whether fears of an inflationary surge, as seen in 2009, are misplaced or not. 

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I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.

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