Quick Take

Spectacular rebound... End of the bear market?

In discussing the situation last week, we concluded that depressed stock prices were more of an opportunity than a threat. The reasons ranged from the scale of the decline in risk assets (suggesting that a lot of bad news is expected at these levels) to the imminent deployment of accommodative monetary and fiscal policies (which keep markets functioning and partially offset the halt in economic activity) to the containment measures (which demonstrate that the pandemic can be contained), and the extreme pessimism of investors (which is often a good contrarian signal).

Following a host of negative shocks, it is no surprise that markets reacted swiftly to a ‘better news’ flow. After the Federal Reserve's announcement of infinite quantitative easing, rumours of an agreement on a $2 trillion U.S. fiscal plan have caused the U.S. stock market index to jump more than 10% in the last two days (March 24 and 25). Is this a signal that the bear market is over?

Hold on a second!

Realized market volatility remains extreme. In the face of a multitude of monetary and fiscal measures, drastic containment plans to halt the spread of the coronavirus, and a lack of liquidity in the markets, daily movements have for some time exceeded what is usually recorded in a full year (Chart 1).

However, upswings of this magnitude are more typical of… bear markets (Chart 2)! Is this a signal that the bottom has not yet been reached?

List of key considerations

In order to determine whether the worst is behind us, we are revisiting our list of key elements to observe, as presented on March 18. Specifically:

1. (✔) Concrete fiscal measures to help workers and businesses. The 2 trillion USD budget plan is the most ambitious ever proposed in U.S. history (Chart 3).

2. (X) A slowdown in the growth rate of new cases of COVID-19 worldwide. The situation appears to be stabilizing in Italy with its highest number of new cases on March 20, but it’s markedly deteriorating in the United States, particularly in New York City, where the number of new cases is doubling every three days (Chart 4).

3. (X) Clearer crude oil supply-and-demand fundamentals. World crude oil prices have rebounded from their lows, but the overall trend remains downward (Chart 5) and inventory surpluses offer a poor outlook (more details to come shortly in a Strategic Report).

4. (-) The flow of credit to be restored to households and businesses. The series of extraordinary measures announced earlier this week by the Federal Reserve (purchases of commercial paper, mortgage-backed securities, corporate debt both on the primary and secondary markets, and even direct lending for small businesses) is a major turnaround and should prevent the worst from happening. However, credit risk and liquidity risk gauges remain high (Chart 6).

5. (-) The stock market to consolidate around current levels. Equity prices remain highly volatile, but emerging and European markets have shown signs of stabilization in recent days. U.S. small caps which have been hit harder (-40% from the peak) have also started to recover (Chart 7).

The bottom line

While some factors have improved over the past week, the overall situation remains precarious and still calls for caution. In addition, we should bear in mind that the magnitude of the economic shock remains largely unknown, given the limited post-Coronavirus data available. Granted, stock market valuations have corrected accordingly – the S&P 500's price-to-earnings ratio is near its lowest since 2013 – but it should be noted that the denominator of this popular valuation measure (earnings estimates over the next 12 months as compiled by I/B/E/S) has fallen by only 3% since the start of the crisis. Certainties are rare these days, but 3% is beyond any doubt far too conservative.

CIO Office

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