The economic shock brought on by the COVID-19 crisis has directly impacted corporate earnings, resulting in dividend slashing and job losses. This is translating into bearish economic sentiment and is driving expectations that markets will continue to experience increased volatility in the short-term.
On a positive note, in the long-term markets are expected to recover strongly based on fiscal and monetary stimulus from governments and medical research to produce the COVID-19 vaccine.
The ‘W’ recovery
In recent weeks, several economists and business leaders like former Westpac boss David Morgan have suggested the economy may not bounce back as quickly as some investors expect.
Changing consumer preferences, poor business and consumer sentiment, rising debt levels and the unique nature of this crisis all point to a W-shaped recovery.
This implies a “double-dip” sloped recovery, rather than a “V” or “U” shaped recovery. The central case behind forecasting a “W’ is due to a cold turkey end to aggressive stimulus packages such as JobKeeper and JobSeeker.
Extending these and other support programs would likely soften the economic shock but will come at the cost of rising deficits and debt levels.
There is now growing momentum behind this theory, backed by the belief that a quick recovery is very unlikely, given the huge amount of disruption and debt it has taken to flatten the curve of the COVID-19 contagion.
While investors may be riding the recent equity rebound, history shows us that strong market rallies following a sharp decline are a recurring pattern.
Even a dead cat bounces
All investors should be wary of the dead cat bounce, a temporary recovery of asset prices from a prolonged decline or a bear market that is followed by the continuation of the downtrend.
The problem is these can be difficult to spot. Particularly when investors start believing that the market has returned, and that things will soon return to normal. It is becoming increasingly evident that “normal” will look very different in the future.
The recent economic slowdown was an engineered response to a health pandemic, not a recession triggered by financial markets. It is easy, therefore, to believe that once the virus is contained and a vaccine found that the economy and financial markets will return to “normal”.
Investors with money in the market will have a positive bias towards this logic but what we are seeing in markets may turn out to be the dead cat bounce.
Ben Streater, chief product officer, Stropro