Johanna Kyrklund: Are opportunities beginning to emerge?
Last week I said valuations are still not cheap enough to warrant taking more risk. After the large falls we’ve seen this week, is this starting to change?
Part of the reason why the market tumble has been so breath-taking is because shares began the coronavirus episode at such expensive levels, particularly in the US.
Such high valuations were precarious and vulnerable to a change in investor sentiment. The result is that since its peak on 19 February, the US S&P500 index has fallen 26.6%, as of the end of the day yesterday (12 March).
So where does that leave valuations now? According to our statistical models, shares are now priced in expectation of a technical recession. This is when an economy shrinks for two consecutive quarters.
Whether a more prolonged recession lies ahead remains to be seen. Our Chief Economist Keith Wade said in an article earlier today that the coronavirus crisis has made him re-assess his outlook for the world economy.
The potential for a longer recession is real, Keith thinks: “monetary and fiscal tools are weak in the face of the virus and until the outbreak is under control the tail risk of a prolonged slump remains high.”
From an investment perspective, I expect the market’s trajectory will go from being a straight line downwards to intermittently heading both up and down for the time being. This is as investors weigh up on one hand the prospect of more lockdowns and a more protracted economic downturn caused by Covid-19, versus the impact of emergency government and central bank intervention.
At current levels markets have now priced a technical recession with a fairly flat outcome for corporate earnings for the year. If we have a longer term economic slump, we would have to assume earnings decline. This would suggest another 10% downside to stock markets from here. This would probably be accompanied by a great deal of volatility as we have the opposing force of policy intervention which could cause short term bounces.
Considering these risks, I would urge caution. Valuations may be looking far more attractive than a few weeks ago, but this is a market for experienced swimmers only. The sea will remain stormy, but under the surface opportunities are beginning to emerge.
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