Could stock markets plunge yet further? Making sense of the current turmoil

Q: How does this compare with previous cycles? The main difference is that it’s been faster; the absolute magnitude of the falls so far is in line with many event-driven bear markets in the past. 

Q: What has been the policy response? Swift and large. Policy has been fast to adjust this time, and we see this as a large positive and likely to prevent this from becoming systemic. 

Q: What is required to stabilize markets? Are we there? In our view, there are four components of this: (i) A sign that the policy intervention is sufficient to prevent severe second- and third-round economic shocks; (ii) A sign that the infection rate is reaching a peak; (iii) A sign that the economic downturn may be slowing; and (iv) Cheap valuations. In reality, we believe it will be a combination of these, and in some cases there are already signs these are in place.

Q: Is this now a ‘structural’ bear market? We don’t think so, given the policy in place. However, if this becomes systemic, (ie, rising unemployment, corporate losses infecting the banking sector and leading to a large-scale credit squeeze) then the market could have further to fall; previous structural bear markets saw the market fall by 50% or more, down another 20-25% from here. 

Q: Valuations are low, but can we trust this signal? Valuation is a necessary but not sufficient condition for a turn; that said, on some measures and especially vs. government bonds, equities are the cheapest they have been historically. 

Q: Will this all lead to inflation? This is a common question and, given the large policy packages delivered combined with supply chain disruptions, we believe this is a risk. However, there are also other factors that may prove ‘disinflationary’ more medium-term too, such as households’ and corporates’ desire to keep a larger cash buffer or some unwind of the inventory build in certain sectors of the economy.

Story by ProactiveInvestors