AT the dawn of 2020, before Covid-19 was on the radar of investors, it was inconceivable that the S&P 500 would slump more than 30 per cent in less than three months.
And, when the benchmark stock index hit those lows in March, amid signs that the whole world was disengaging from economic activity, it seemed very unlikely that it would recover all the ground it had lost in less than three months. Yet, in early June, the S&P 500 briefly surpassed the levels at which it was trading at the beginning of the year.
The S&P is now less than 5 per cent below where it began the year.
More than anything else, the rebounds were driven by massive central bank stimulus. In particular, the US Federal Reserve took dramatic action in March, as markets were tanking. It slashed rates twice, all the way down to 0-0.25 per cent, and committed to another massive bond buying programme.
The Fed also took measures to ease US dollar liquidity around the world. On March 19, it said that it would initiate temporary US dollar swap lines with nine other central banks, including the Monetary Authority of Singapore (MAS).
Many stock indices have mirrored the S&P 500's recent trajectory, though the extent of their falls and rebounds vary. The Nasdaq 100 index, for instance, was down nearly 20 per cent for the year at its low point in March. But it has rebounded so strongly that it is now more than 14 per cent up versus the beginning of the year.
On the other hand, the Russell 2000 index, a key small-cap US stock index, was down more than 40 per cent in March. It is now about 16 per cent below where it was at the beginning of the year.
In Asia, the Hang Seng Index was down more than 23 per cent in March, and is now about 12 per cent below where it was at the beginning of the year. The Straits Times Index was down nearly 31 per cent in March, and is now nearly 20 per cent short of where it began the year.
Now, many analysts and investors expect the Fed to maintain a strongly dovish stance for the rest of the year, which should help support the markets.
"Against this backdrop, we think the most important thing an investor can do is to be invested, not sit on the sidelines. We are positive on the outlook for both equities and credit," Kelvin Tay, regional chief investment officer at UBS Global Wealth Management, told The Business Times by e-mail last week.
"The Fed is all in, and will remain so until US unemployment drops to below 5 per cent," he added.
SHORT, SHARP RECESSION
Indeed, there appears to be broad consensus that the worst of the Covid-19 pandemic is behind us, and that the slump in economic activity that it took to bring it under control is coming to an end.
Moreover, this recession did not follow a build-up of economic imbalances or over-investment. By contrast, prior to the Asian Financial Crisis of 1998, countries in this region had been running persistent current account deficits. And, in the years leading up to the Global Financial Crisis of 2008, the US saw a huge housing boom supported by sub-prime mortgage debt.
Consequently, the recovery that ensues this time around is likely to be much steeper, because most major economies would not have to endure a lengthy period of deleveraging. In the US, for instance, consumers were in relatively good shape before Covid-19 emerged, and housing prices have held up well.
"We think this recession will likely be sharper but shorter than the Global Financial Crisis in 2008," said Mr Tay of UBS, adding that he sees GDP for the G-10 nations recovering to their pre-Covid-19 levels by 2022.
"Stable private sector debt coming into this crisis, suggests that deleveraging pressures in this cycle will be more modest. This in combination with healthy credit supply and plentiful policy support should mean a shorter cycle.
The most obvious risk for investors at this point is the possibility of a "second wave" of Covid-19 infections that scuppers efforts to re-open economies around the world. Another emerging concern is the outcome of the US elections later this year. With Donald Trump's poll numbers deteriorating, some market watchers fear the US Democratic Party may gain control of the White House and perhaps the Senate, which might mean higher corporate taxes.
In early June, markets around the world suffered a sell-off on these concerns, with the S&P 500 falling more than 7 per cent over two days. But some analysts saw it merely as one of the many passing squalls that investors will have to navigate as they take advantage of the increasingly bullish environment.
"While news headlines can make us think the second-wave and election stories are the biggest drivers for markets, it is the Fed story that will endure over the medium term," said Mr Tay.
"Ultimately we think the Fed's efforts will continue to support capital in risk assets," he added.
Eli Lee, head of investment strategy at the Bank of Singapore, expressed a similar view shortly after the sell-off. "Clearly, the situation regarding infections will continue to evolve. At this point, however, there are some grounds to be hopeful that the economic impact of subsequent waves of infection will be relatively contained," he said in a statement.
He added that policymakers have already gained some experience in managing the virus, and there is reduced political will to re-impose full shutdowns that would disrupt economic activity again.
Meanwhile, efforts are underway to come up with vaccines for the virus, and policymakers seem ready to provide more stimulus if necessary.
"Therefore, it seems unlikely in our view that the equity market could revisit the levels of the March bottom, which were reflecting far greater levels of uncertainties. That included the real risk of a greater financial blow-up stemming from the tremendous liquidity pressures at that time, which is now mostly diminished," Mr Lee said.
TOO FAR, TOO FAST?
Yet, with all the stimulus that has already been provided, some analysts think the markets have run up too quickly - a case of Wall Street becoming untethered from Main Street.
MFS Investment Management's chief economist Erik Weisman, and global investment strategist Robert Almeida, warned in a recent commentary that investors might be over-estimating the impact of the unfolding economic recovery on corporate earnings.
While the lifting of lockdowns will spark a steep rise in economic activity, many companies will not see their revenues fully recover.
"While some may resume visiting theme parks, patronising coffee shops and staying in hotels, not everyone will. Quite a few won't feel comfortable boarding a plane or sitting in a crowded restaurant until a safe vaccine is widely available," they pointed out in the commentary.
"So while a company operating at 75 per cent of 2019 revenues is materially better off than the 15 per cent level it may have operated at during the lockdown and naturally warrants a re-rating of its enterprise value, that re-rating should only go so far, and certainly not back to pre-Covid-19 levels," they added.
Moreover, many companies had been burning cash during the lockdowns and adding to their debt loads. "Borrowing to replace lost income, rather than investing for the future, weakens, not improves, balance sheets. Businesses are structurally weaker today than they were before the crisis," Mr Weisman and Mr Almeida, said in their note.
"In our view, the combination of only a partial recovery in sales and increased financial leverage (despite low financing costs) decreases the probability that the S&P 500 will meet consensus earnings per share or free cash flow expectations."
Yet, the markets have been discriminating in their rebound from the March lows. One key reason cited for the S&P 500's relatively strong recovery is that it is heavily weighted towards technology-oriented companies that were not too badly affected by the lockdowns. Facebook, for instance, has seen increased use of its platforms, though it does face the risk of general weakness in advertising spending.
Paras Anand, chief investment officer for Asia-Pacific at Fidelity International, said in a recent commentary that Covid-19 has created both winners and losers.
"For example, we've seen recently that many businesses have accelerated topline growth thanks to a step-change in demand for digital services."
"Performance becomes even more sharply bifurcated," he added. "Just looking, for instance, at the S&P 500 over the last three months, we see as many subsectors showing material positive returns as those showing negative returns; with such a high level of dispersion, the returns on the broad index carry little meaning. In other words, time spent trying to determine if we are in 'risk -on' or 'risk-off' markets could simply be time wasted."
Companies are also dynamic entities, responding to new opportunities and risks that arise. And, economic dislocation can be a catalyst for entrepreneurial firms to expand in interesting new directions.
Rob Sharps, head of investments and group chief investment officer at T Rowe Price, said in a recent commentary that we might be entering a "golden age" of technological innovation. "While tech giants have thus far led the way on digitalisation, investors may find some of the best investment opportunities in smaller industry upstarts, which are exploiting emerging areas where online services are making communicating, doing business and transacting easier, improving productivity, and engaging customers," he said in the commentary.
BET ON CYCLICALS
So, how should investors position themselves at this point?
Mr Sharps noted in his commentary that value-oriented stocks have underperformed growth-oriented stocks during the Covid-19 pandemic. "The challenge is identifying those that can get to the other side of this crisis. In the US, there are opportunities to buy high-quality cyclicals, especially information technology and industrial companies that are developing innovative products, as well as bank, food product and consumer discretionary categories in the large-cap space."
Mr Sharps also said he is looking to the utilities sector, "amid upgrades to infrastructure and a push to harden these critical systems against natural disasters". He added: "We believe semiconductors could also be a good pick as the current environment is expected to further accelerate the proliferation of the Internet of Things".
In the fixed income space, Mr Sharps figures "compelling opportunities" could emerge in the energy sector when investment-grade issuers get downgraded into the high yield universe, triggering waves of selling by funds that can only hold investment-grade bonds.
Within the high yield universe, he is positive on the larger exploration and production companies with low gearing, and high quality midstream players with diverse customer bases.
Morgan Stanley is advising investors to position themselves for an acceleration in economic growth, rising inflation and improving consumer confidence. "We're believers in the recovery, which means the primary trend is higher for cyclicals versus the market," the research house said in a recent report. "Corrections are normal after rapid moves higher, and we will continue to add cyclical exposure on weakness."
For instance, it is recommending an overweight position on US financial stocks. "Financials continue to trade at depressed multiples on a relative basis," it said in the report. Moreover, stronger GDP growth and rising inflation would boost interest rates, which would be positive for banks.
Morgan Stanley is also overweight on industrial and materials stocks, which generally do well when economic growth and inflation rise.
And, it is positive on healthcare stocks, though this is more of a defensive than cyclical sector. These stocks are currently trading at low valuations and offer durable earnings growth.
On top of that, these stocks might benefit from a re-rating once the uncertainty of the US elections passes, according to Morgan Stanley.