Have markets got the all clear?
Last week’s bounce in US company share performance reflects investors’ new-found optimism. Here’s why we’re still cautious.
So what explains investors’ sudden optimism following several weeks of market falls? Essentially, the market reacted very positively to the massive levels of support for people and businesses promised by governments around the world. This was especially true in the US where President Donald Trump signed a bill which provides over $2 trillion, the largest such support package in US history.
And support is not just coming from the US government. The Federal Reserve, the country’s central bank, announced last week that it would buy US government bonds, known as US Treasuries, in the “amounts needed to support the smooth functioning of markets”. This immense purchase of US Treasuries, some $75 billion a day, has helped give greater confidence to investors that the Federal Reserve is committed to living up to its promise.
So are markets out of the woods?
Overall, we believe the risk of a crisis that threatens the stability of the financial system has reduced thanks to these developments.
But despite the optimism we’re seeing in markets, we’re not convinced that investors are out of the woods just yet. Our reservations fall into three main categories: economic, earning and the epidemic.
In our view, investors are understandably hoping for a quick economic recovery, sometimes known as V-shaped, as a sharp decline in output would be soon followed by an equally fast rebound.
However, our economists believe that the recovery may be more U-shaped instead. Under this scenario, the virus continues to spread and the restrictions on movement and businesses will likely be in place for at least several more months to prevent further outbreaks.
- Company earnings
The restrictions in place are forcing non-essential businesses to close and people to stay at home. People are therefore spending less money on goods and services, and many businesses are faced with greatly reduced earnings. For instance, airline company EasyJet grounded its entire fleet of planes due to the virus and stands to suffer major losses from a lack of people travelling.
Support from governments and central banks may alleviate some of the earnings pain, but we don’t know to what extent yet and any positive impact is unlikely to have registered by the time of the next reporting season.
- The epidemic still has not peaked for many
Last Friday’s figures about a record 3.3 million US residents filing to receive unemployment insurance are likely to be just the beginning of negative economic headlines about the impact that COVID-19 will have on our societies. As the lockdown on people’s movement and business continues, and potentially intensifies, so will its impact on markets and investments.
Many people are hoping that last week’s positive performance marks the ‘bottom’ of the fall in company shares but we’re remaining cautious. Sudden bursts of optimism rarely endure when there are still risks to companies’ earnings and future growth. As always, we believe that good long-term investing is about time in the market, and not trying to time the market.