Market Summary March 2020: Covid-19 Outbreak

Economic impact and earnings outlook downgraded through March due to worsening coronavirus

As the number of coronavirus (COVID-19) cases has escalated exponentially around the world, forecasts of the extent of the impact on economic growth have become more pessimistic in the past month. Consequently, equity markets suffered significant declines in March and the US Dow Jones index registered its largest ever first quarter decline of 23%. To provide some protection, we switched some equity exposure to precious metals and cash earlier in the year, closed the remaining direct equity exposure in March and held off on some regular rebalancing (thus avoiding chasing declining equity market exposure). Many fixed income assets were also negatively impacted, especially the US high yield sector which is vulnerable to the 66% first quarter decline in the oil price. The path of markets moving forward will depend to a large extent on the speed of the recovery when it comes. However, as volatility remains high, we are for now maintaining elevated cash levels.

Corporate earnings estimates have been downgraded in tandem with the growth forecasts, due to significant contraction in demand for non-essential goods as more and more countries have opted to impose lockdowns to contain the spread of the virus.

Investment banks Goldman Sachs, Morgan Stanley and JP Morgan have in the past fortnight reduced their forecasts for US growth, now the epicentre of the pandemic, and a global recession seems inevitable. Current published forecasts are cited below.

Against a fast-deteriorating world economic backdrop, 2020 corporate earnings estimates are becoming harder and harder to quantify with any reasonable degree of certainty. Dozens of European and US companies have either withdrawn or dramatically reduced 2020 guidance over the past month and analysts have been sharply reducing their earnings estimates as indicated in the graph below. As is often the case, the stock market reflected the changing outlook more quickly.

The industries hardest hit and set to record the most significant declines in earnings growth are, unsurprisingly, the energy, consumer discretionary and industrial sectors, while the utilities, real estate and information technology sectors are less affected in the short term.

Analysis now shows earnings for the S&P 500 anticipated to decline by 5.2% in Q1 2020, by 10.0% in Q2 and by 1.1% in Q3. These figures may still be optimistic.
Meanwhile, investors have been trying to ascertain whether the short-term declines in activity will be followed by a sharp, V-shaped recovery, a U-shaped recovery after a few quarters or an L-shaped recovery that does lasting damage extending into 2021 and beyond.
A typical model for Europe, as shown in the chart below produced by Berenberg, assumes a severe lockdown of about eight weeks that will be eased from late May onwards with many activities switched on step-by-step, but some activities, such as long-distance travel, restrained for much longer. The fiscal stimulus is assumed to partly offset some hesitation by consumers and companies to spend.

There are a number of factors to look out for that would give rise to further optimism. These include: 

  • antibody tests driving a slow back-to-work process (especially if a greater proportion of the population than expected has been infected)
  • development of anti-viral antidotes which reduce the mortality rate of those infected
  • increase in healthcare capabilities allowing a gradual return to work, as those catching the virus can either remain quarantined (especially if elderly) or be treated with enlarged healthcare capacity
  • a vaccine, though this would be longer-term
  • it turns out through larger testing samples that the mortality rate is far lower than expected, and is ‘acceptable’, allowing a faster return to work 

On the other hand, investors could turn more negative if:

  • the reality of tens of thousands of deaths across Europe and the US sharpens minds around the severity of the virus
  • lifting of lockdowns results in a second wave and therefore further lockdowns
  • substantial job losses result in lower consumer spending for several quarters
  • in spite of rescue packages, there are more defaults than expected and knock-on effects to the availability of credit
  • concerns grow on the spectre of inflation as money-printing’s moral hazard becomes more evident, especially if further bailout packages are required

We will be making quick market judgements as developments relating to the virus emerge. While monetary policy and fiscal stimulus have so far contained the economic impact, it is improvements in managing the virus that are most likely to indirectly lead to any sustained market rebound. In the short term there remains much uncertainty, but it is important to bear in mind that this type of backdrop has historically provided some of the best investment opportunities which, by the time there has been clarity, have passed.