As mentioned in my previous update, financial markets have recently rebounded from their lows. So following the very difficult month of March, the first half of April is looking much more positive: as of yesterday’s close, the benchmark S&P 500 equity index is up +10% in April (and up +27% from the March 23rd low). So far, given the significant rebound from market lows, our approach of staying patient while closely monitoring events and markets seems to have worked well. On the way, where appropriate, we have also been able to take advantage of lower market prices to rebalance portfolios and add some exposures at more attractive levels.
Investors are clearly encouraged by signs that social distancing and lockdown measures are proving effective in fighting the spread of Coronavirus. Moreover, systemic risks (the risk of the collapse of the financial system) have been greatly reduced by aggressive action by the major central banks, particularly the US Fed. As explained previously, in order to support financial markets (and indirectly, the economy), the US Federal Reserve is now buying a fairly wide range of financial assets at an accelerated pace. In this process, the Federal Reserve’s balance sheet has recently increased to over $6 trillion, a record (see chart below). In the four weeks since the Fed slashed interest rates to zero, restarted bond purchases and rolled out an unprecedented range of programs to limit the economic damage from the outbreak, the size of the central bank’s balance sheet has jumped by about $1.7 trillion. Bond holdings surpassed $5 trillion for the first time. Bank of America analysts believe that continued Fed action on all these fronts could result in the Fed’s balance sheet topping $9 trillion by the end of the year. Given the Fed’s immense monetary firepower, some investors will say that it might be unwise to ignore the old Wall Street adage “Don’t fight the Fed”.
Total Assets of the Federal Reserve (in $ Millions)
Meanwhile, on the economic front, the activity data for March and April is terrible, as expected. Yesterday, the International Monetary Fund (IMF) released its assessment of the economic impact of government measures to contain the spread of the virus. The IMF currently forecasts that global growth will contract by -3% in 2020. The 2020 economic contraction is therefore expected to be the worst in decades, worse than the economic recession experienced during the 2008/2009 global financial crisis (see chart below). They are also predicting a +5.8% global growth rebound in 2021 – however, given the uncertainties around the containment of the virus and the timing of relaxation of lockdown measures, their conviction around the 2021 forecast is, at this point, very weak.
IMF Growth Forecasts (April 14th, 2020)
Finally, the Q1 corporate earnings season has just started. At this point, investors are already expecting a significant drop in earnings for Q1, and for the remaining quarters of 2020 – see chart below. In terms of the usefulness of Q1 numbers in assessing what the future holds, I doubt they will be very useful. The first quarter straddled a period when the virus went from having no effect on economic activity to shutting down entire sectors. We may, however, be able to learn something from what company executives say about the future.
Bottom-Up Consensus S&P 500 Earnings-Per-Share Growth Estimates