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Making Sense of Extreme Market Moves

By:

Global Chief Investment Officer

While most commentators anticipate a V-shaped recovery, investors’ buying and selling actions reflect much more ambiguity. It is essential not to be swayed by judgments that either gloss over the difficulties or extrapolate challenges too far into the future.

Key Points:

  • Opinions on the economic trajectory and corporate performance differ widely
  • The dispersion in analysts’ forecasts means fat tails in the distribution of expected returns
  • This crisis has boundaries; consequently, we look beyond the next quarter or two when forming our investment views

March marked the beginning of big adjustments – certainly, at a personal level for those under lock down, those now working from home and those with no work at all. This was also the month in which China began to unlock its people and its industrial activity rate jumped. In addition, equities had their speedy descent, followed by a recovery of roughly half the equity losses1. Credit spreads were somewhat steadier although hardly functioning normally. Investors struggled to evaluate wide-ranging forecasts, and at times, security prices seemed to create their own narrative.

Uncertainty Now Driving Stock Prices More Than Fundamental Insights

Professional analysts are significantly less certain about the future than when we were at the brink of normal recessions. After all, the COVID-19 crisis is health driven whereas previous crises were rooted in economic or financial conditions. Due to twists in the path of the virus and the wide-ranging points of view, financial markets have become disjointed with incongruent expectations. In other words, the “legs” of the V-shaped outlook can be narrow or wide depending on whom one asks and may even approach more pessimistic shapes.

Let us look at the European auto industry as one example. Bottom-up revenue estimates for the STOXX600 Autos and Parts sub-index2  reflect a remarkably shallow V given the supply chain disruption and weak near-term demand; an overall -6.9% is expected for 2020 over 2019 followed by a 6.5% rebound in 20213 . In contrast to mild trims to revenue forecasts, investors were much more pessimistic and pushed the sub-index down nearly 25% reaching a bargain price-earnings ratio of 74.

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Footnotes

1 For example, the S&P500 moved peak to trough 3,130 to 2,192 and trough to peak 2,192 to 2,637

2This index measures the performance of large, global integrated manufacturers as well as various euro-based businesses.

3Factset, as of 31 March 2020.

4Factset, as of 31 March 2020.

5The fall in the narrower Eurostoxx50 dividends is also steep with an estimated 32% drop in expected 2023 dividends.

Originally Posted on April 6, 2020 – Making Sense of Extreme Market Moves

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