Excerpts from Global equities: Uncertainty everywhere by RBC Wealth Management which is part of the Royal Bank of Canada.
The depth and duration of the equity correction will depend on how deep and for how long COVID-19 impacts North America and Europe as well as how effective fiscal and monetary stimulus measures prove to be.The economic news in the weeks and months directly ahead will be unsettling, to say the least. But our forecast has the effects of the epidemic waning in the second half of the year, permitting investors to focus their attention on the prospects for a resumption of stronger growth in 2021.
Implicit in the aid and stimulus packages is the idea that infection rates and the number of daily new cases should be in decline in most countries well before Q2 ends, raising a realistic prospect of social and commercial conditions improving in Q3, with a more pronounced rebound evident in Q4. That is our expectation and operating forecast.
".... economies have the potential to recover quickly in the second half of this year because the hits to labor supply and product demand are largely due to “stay at home” and “work from home” government edicts being implemented for public health purposes, and can be rapidly reversed when the virus wanes.”
China has already demonstrated this is possible. The country was able to restart its economy within a few weeks of its infection rate (i.e., how many people one person with the virus is likely to infect) falling below one.
South Korea, surprised by an explosive outbreak in late February, has pulled its daily new cases from close to 1,000 down to less than 100 in just a few weeks.
Our scenario of an April/May peak in the number of cases and quick economic recovery is only one of many potential outcomes. The “wishing and hoping” scenario—i.e., the pandemic peaks sooner, recedes faster—seems unlikely to materialize. The “slower to peak and to recede” version would deepen the economic impact and likely produce a fresh round of equity market volatility.
Two phases of the pandemic, with the second beginning this fall and carrying into next spring, would not be unusual from a historical perspective (the Spanish Flu had three waves). This raises the possibility that 2021 might experience another period of economic contraction.
None of these scenarios can be said to be the one most likely to occur, leaving the outlooks for the economy and corporate earnings very much in flux in the short term.
It is worth remembering the “value” of an individual business and of the equity market as a whole is the present value of all future earnings—i.e., investors are buying into a multiyear stream of earnings. Looked at that way, even big, unexpected changes in the near-term earnings outlook shouldn’t have a large impact on the market value of corporations. But they usually do because, for a while, investors come to believe that the performance of the economy and market today are pointing to an altered trajectory for economic and earnings growth in the future.
Looking back at a century of pandemics, wars, nuclear disasters, and more, that sort of conclusion has not been useful. Within a year or two, the forces of global population growth and rising prosperity tend to reassert themselves and, before that has happened, stock markets have gone back to capitalizing future earnings appropriately.
We do not believe COVID-19 will cause a permanent hit to the profits of most companies. Not even the Spanish Flu of 1918—a much more deadly pandemic that killed more than 40 million mostly young adults worldwide with three rounds of mass infection—resulted in enduring damage to economic growth.
Here are some of the developments we are watching for that could potentially put us back in an environment where future rewards considerably outweigh near-term risks:• Arrival of a clear peak in the number of daily new cases in the developed economies, but particularly in the U.S., together with a drop in the infection rate to levels (less than one) indicating that the spread was under control and diminishing.
• The identification of an agreed short list of vaccine candidates where indications of efficacy are good, and a testing start date is determined.
• The arrival of positive test results for some of the many anti-viral therapies under consideration.
• An exponential increase in the availability of test kits and facilities, both for rapid detection of new infections and for detection of the presence of anti-bodies, implying immunity. Both are key to gauging the advisability of easing/lifting travel and social restrictions.
• Indications that fiscal measures are having the desired effect.
• Some retreat in corporate bond yields that would take pressure off P/E multiples.