Financial markets: Investors have cause to be optimistic about a stock market recovery

Recovery for financial markets? Eight good reasons.

Coronavirus has infected stock markets worldwide, unleashing an unprecedented financial market tsunami. But those who demonstrate endurance today will profit tomorrow. Why a recovery is likely, and how investors can exploit it.

Stock market tsunami: Why the crisis is so complex

The financial market developments of recent weeks have no precedent. This is no normal crash, but a tsunami of fear. Investors are obviously asking themselves: How much further can stock markets fall? But also: When can we hope to see a recovery, and what form will it take? Specific forecasts are pointless in the current uncertain environment.

How long the economic shock persists, and how quickly the economy can recover, will depend greatly on the success of the fiscal support provided to companies facing liquidity bottlenecks. According to the market consensus, growth in the second quarter could decline by an average of 4 to 6 percent (p.a.). Over the year as a whole, corporate profits can reasonably be expected to decline by between 15 and 20 percent. But for many companies, there will be a gulf between the average and their individual situation. For that reason, diversification will be essential in the recovery phase too. In the ideal scenario, investors can expect to see a recovery set in from the summer onward. On the positive side, there is a plausible case for arguing that the restructuring measures taken in response to the crisis by companies today will strengthen productivity in 2021.

Optimism: Why a speedy recovery of financial markets is likely

Despite the current stock market tsunami, investors should not forget that there are a number of very good reasons to expect the economy to recover in the summer – as long as we can actually master the current pandemic:

1. Despite the stock market crash, the financial sector remains an anchor of stability – and will probably be a part of the solution, rather than the problem, in overcoming the impending recession. Banks have record-high levels of capital and plenty of liquidity. Moreover, they have massively reduced their direct market risks since 2008 and have improved the quality of their collateral.

2. Contrary to what many people assume, the guardians of monetary policy possess sufficient "ammunition" even in an era of negative interest rates. Compared to the size of the respective economies they represent, the balance sheets of the US central bank (Fed) and European Central Bank (ECB) are no more than a third of the size of the Swiss National Bank's balance sheet. This alone shows why both the Fed and the ECB still have considerable – and theoretically almost unlimited – resources. Which among other things can be used as a "last resort" to break the spiral of fear through purchases of bonds or equities.

3. It has become clear that the current practitioners of fiscal policy are ready and willing to act in tandem with their central banks. For example, the latest announcement of a Pandemic Emergency Purchase Program on the part of the ECB suggests that both countries and companies could put in place indirect incentives to issue "pandemic bonds."

4. Discussions are being held in all EU capitals on state-funded continuing salary payments, credit guarantees for SMEs, infrastructure measures in the healthcare sector and the digital economy, and even "helicopter money." "Whatever-it-takes" fiscal stimuli packages are being prepared across the board.

5. Since private households were in a healthy economic state prior to the crisis, consumer spending could in principle recover swiftly once emergency measures are lifted and life returns to near-normal.

6. Fiscal policy may have its political limits, but there are currently no financial limits. As things stand, (almost) all of the Western governments can essentially refinance themselves for free. In unique situations such as these, there is a plausible case to be made for every country at least temporarily adjusting its fiscal policy rules in order to overcome the crisis.

7. A natural floor to prevent further stock market slumps is being created by extreme undervaluations. The majority of leading indices have recently plummeted by more than 25 percent from their peak levels. Many companies are already trading far below the value of their assets and investments. Value investors with liquidity can now choose from a rich spectrum of possible targets thanks to this sell-off. Sooner or later they will create a natural support level.

8. According to Bloomberg, long-term yields in the bond markets have risen from –1 percent to –0.4 percent over the last week or so. Why? Because announcements of huge fiscal stimuli packages have the immediate effect of increasing long-term yields.

Everything will be fine in the end – including in the stock market

Finally, a comparison of all the major stock market crashes of the last century – 2008, 2001, 1987, 1974, 1949, and 1929 – shows that, almost without exception, a substantial proportion of the correction is made good over the next six to twelve months. Students of stock market history have good reason to recall Oscar Wilde's bon mot: "Everything is going to be fine in the end.
If it's not fine it's not the end."

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