11:30pm GMT – Why’s the market up today? More buyers than sellers. Why was it down before? More sellers than buyers. There’s no point in over-complicating the explanations when we’ve got enough to worry about. Here’s Barclays:
Money market funds saw record inflows in March as risk assets collapsed. Systematic/HF selling is well advanced, but equities remain vulnerable to LO/Retail capitulation and are losing the bid from buybacks amid a worsening earnings and macro outlook. Continued caution is thus warranted but month-end pension funds’ rebalancing following the extreme equity/bond underperformance in Q1, along with decisive central banks’ action,could provide a near-term backstop to the markets and reduce volatility.
Cash is king. As the COVID-19 crisis worsened, investors shifted a record amount of assets to cash in March. Equity selling mostly came from HF& systematic investors, but LO de-risking was less aggressive, in particular compared to Credit. Retail has not capitulated either, given resilient inflows to passive equity funds, although some popular US ETFs saw big redemptions last week. The steady outperformance of Momentum, Quality, Low Vol and Growth factors vs. Value, as well as the strong ESG inflows and performance, are also not indicative of panic selling by retail investors, in our view.
Buybacks cancellation vs. pension funds’ rebalancing. The list of companies suspending share buybacks is growing fast, as earnings recession looms and financial conditions are tightening. Materials, Staples and Energy, which all increased buybacks in recent years, look the most at risk to us in Europe, and we note that buyback indices have underperformed during the sell-off. Against that, rebalancing by pension funds could provide a welcome bid to equities,in the near term at least. The equity/bond underperformance this quarter is near the worst on record, at -40% in the US and -30% in Europe. As a result, pension funds are now materially underweight equities/overweight bonds compared to their target allocation.
Roadmap ahead. We expect the market environment to remain challenging as long as the pandemic keeps expanding in Europe and the US – a stabilization of new COVID-19 cases in Italy would be a ray of hope. Meanwhile, central banks’ action is unprecedented, with the Fed and ECB basically monetizing the increase in government debt. This is powerful, but more fiscal support isn eeded–the passage of the stimulus bill in the US would be positive. The macro and earnings newsflow will indeed likely worsen before getting better.
Might as well wrap up today’s recession forecasts while we’re here, though they all say much the same thing. This one’s from UBS:
We cut our 2020 top-down EPS forecast to -33%
We incorporate the deep recession forecast of the UBS global economists into our topdown earnings model. This points to -33% EPS growth in 2020. We assume a slightly stronger bounce back in 2021 than the model suggests (+25% vs +18%) as we believe the shape of the profit recovery is likely to be different than previous recessions. This still gives us a total fall in earnings over 2020 and 2021 that is similar to the fall in the Global Financial Crisis (2008-10).
New index targets for end-2020: Stoxx 600 = 340, FTSE 100 = 6,400
Even after putting through recession style cuts to earnings we have 12% upside to our new index target of 340 (Stoxx 600). We see greater upside in the UK (+18%) given the starting point of extremely stretched valuations. We also show upside and downside scenarios for both Europe and the UK.
What to do on timing? Don’t track consensus…
Even before the Coronavirus, we saw double-digit downside risk to consensus earnings estimates. These are finally starting to move, but as with previous recessions are likely to trough well after the trough in equities (c.10 weeks). What might be the catalyst or timing for any turn in equities? We suspect it is likely to revolve around lower new daily cases outside of China and the implementation and credibility of the US fiscal package. It may be the case that Asia is a lead steer for the rest of the world.
UBS also runs some quantitative stock screens based off the GFC performance. Being quantitative they make no allowances for how businesses and sectors have changed over the past decade or in the past month, so it’s very much DYOR territory. Here’s the “what’s big, good and cheap relative to history” one:
And here’s the “what still looks cheap once you throw in EPS getting crushed” one:
Also, here’s Credit Suisse:
New EPS growth forecasts: Our US strategist has taken US EPS growth down to -25% in 2020 and +20% in 2021. Our models agree, and for Europe we take it down to -32% in 2020 and +25% in 2021.
Economics forecasts: Our economists have taken their euro area GDP forecast down to -4% and -0.9% for the US for 2020, but importantly forecast that the level of pre-virus GDP will be hit by the middle of 2021. We believe that, as occurred in China, global PMIs will fall to around 30, which would be consistent with a trough of -c.2% global GDP growth.
Markets: The key issue is the multiple on the new depressed earnings: a normal bear market sees a 35% de-rating compared with 30% so far, but we think consensus earnings are c30% too high. We believe central banks will permanently depress real bond yields relative to GDP growth, and therefore that the equity risk premium model is the appropriate model to use, rather than absolute P/E multiples. The rise in credit spreads has pushed up our model of the warranted ERP from 4.6% to 8.2% against an actual of 8.6%. If we assume that ISM ends the year at 50 and spreads fall marginally, then S&P 500 fair value is 2,700. The non-US Shiller P/E at 10.1x is back to levels from which it has bounced over the past 40 years.
Why do we think markets can be 15% higher by year-end?
On the shutdown: We assume a six- to eight-week full lockdown in Europe and the US, before the majority of workers return, on the basis that in two to three months’ time treatments, testing and ventilators will be far more able to accommodate a second spike (which, with social distancing, should be well below the first spike in infection). Moreover, c.85% of people most at risk are not economically active, and where testing is highest, the mortality rate is 1% or lower. Korea and China provide a template for production resuming without a large rise in infections. Overall, this means that the welfare cost of not returning to work in two to three months could be considered higher by policymakers than the welfare cost of a lockdown.
On a permanent loss to growth: Central banks and governments are now nationalising credit risk and, in some instances, wages. Fiscal stimulus is starting, and is vast where announced (5% of GDP is likely in many regions). It is set to be stepped up and financed by open-ended QE, where necessary. Our main concern is US corporate leverage, which had been high.
Other factors that are supportive: 1) Central banks are suppressing real rates and pushing investors into real assets; 2) excess liquidity and monetary conditions; and 3) we have seen the average bear market (35% vs 33% from peak to trough) and bear markets (accompanied by a recession) rally 20% two months after their lows.
The timing of the low: On our scorecard, we now rank 3.4 out of 5. The conditions of a trough we have seen include some anxiety about tactical indicators, capitulation, yield curve steepening (via inflation expectations), major fiscal response and QE. However, we want to see a peak in the US dollar, a trough in PMIs (April) and peak in non-Chinese infections, especially in Italy (during SARS, HK troughed a month after the peak in the infection rate). Credit tends to lead equity at major market turns.
Risk case: If economic lockdown lasts for six months and US corporates de-lever, we forecast -40% EPS growth in 2020, 15% in 2021 and the S&P 500 declining to 1,600.
Possibly the most interesting bit of that is “How much GDP is lost permanently?”
Credit Suisse assumes a two-month total shutdown and gradual restart, with business models not changed in any fundamental way by the crisis. Governments won’t let businesses go into bankruptcy on a wide scale and won’t want debtors to take control of these companies, as they’ll be interested in wind-downs for the assets rather than flying planes, running pubs and whatnot. “The point is that the [state] policy is being put into place, and could easily be ramped up. In effect, the governments, via the central banks or directly, are nationalising the credit risk,” CS says.
Bailing out SMEs, accounting for around 57 per cent of GDP in Europe, is trickier “but we think with the use of modern technology (such as internet banking) governments will work out some form of mechanism (ie, tax credits or even tax repayments)”, CS says. Then add in a “massive fiscal response” via direct payments or spending vouchers to individuals and open-ended backstops from central banks. It all has to help. “The key is that if these measures are not enough, they will simply be ramped up and financed by the central banks. The mechanisms are now in place.”
However, the US corporate sector is looking fragile and corporate confidence metrics were pretty low even before Wuhan got us all in check.
Nevertheless, the 2020 crisis isn’t like the 2000 one involving overinvestment in tech, or the 2008 one involving bank deleveraging. We entered this crisis with a heap of debt not without a bubble to burst, CS says. And it is, according to the broker, very much as US problem alone.
And finally, the $5tn dollar question:
Who pays the bill for all of this?
The long-term outlook for equities depends on who pays the bill for the interventions … There are ultimately three ways to reduce government debt to GDP:
increase corporate and household taxation;
or through negative real rates.
Of these, the final option is by far the most politically expedient. Fiscal stimulus is likely to be funded by the central banks (in effect ‘helicopter money’). [W]e have already seen QE being stepped up significantly in the US, the UK and Europe.
When we come out of this period of lockdown, we believe it will be into a V-shaped recovery (which remains our core case), and we will eventually end up with higher inflation as governments and central banks will likely be slow to switch off the stimulus. Even before this crisis, central banks were debating the degree to which they would allow inflation to overshoot (on the upside). Therefore we think negative real rates will become a very long lasting feature.
Ultimately, the creditor pays the bill through the mechanism of higher inflation and lower real rates: 1% off real rates when government debt to GDP is 100% allows governments to run permanently 1% higher budget deficits.
At the moment, the ability of governments to spend works particularly well because there is the illusion that inflation can never pick up (if we look at inflation expectations) and investors are prepared to buy the bonds.
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