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A bumpy road ahead

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Year-to-date DJIA vs S&P500

By Hussein Sayed, Chief Market Strategist at FXTM

The world has finally seen a glimmer of light at the end of this dark tunnel. The coronavirus outbreak is starting to level off across many countries and cities. Looking at the rate of new daily infected cases and death toll from Spain, Italy, Germany and France, all of those countries seem to be heading into a downward trajectory.

Meanwhile, in the US, the governors of New York, Louisiana and New Jersey pointed to cautious signs that the virus outbreak may be starting to flatten.

It saddens me to use a ‘death’ indicator as a financial market tool, but that’s what’s driving investors at the moment. The declining number of deaths registered due to COVID-19 suggests that we are winning the fight against this horrible virus. Total death rates had decreased from 13% at the start of April to 7% on Monday. That’s the first time we have seen a single-digit number since March 14.

The drop in newly infected cases and death toll sparked a sharp rally in equities, with US stocks registering its best day in a fortnight – and its eighth best day since the end of the second world war – as the S&P 500 and Dow Jones Industrial Average both rallied more than 7% on Monday.

At this stage, markets are repricing the worst-case scenario due to the virus outbreak, but in my opinion, it’s still too early to justify a prolonged move higher.

Investors moving into risk assets at this stage believe that we’re heading into a V-shaped recovery. Attractive valuations, ‘fear of missing out’ and extraordinary stimulus packages also exaggerate the upside moves in prices.

However, no one yet knows the exact damage this virus has already done to the global economy, corporate earnings, and what kind of exit strategies countries will follow in the weeks ahead. Without proper treatment or vaccination, lockdowns could be re-imposed and the global economy will then continue to suffer.

The corporate earnings outlook is also very murky as the dispersion of analysts’ forecasts are near a record high.  Hence, the road ahead won’t be a smooth one, especially as investors still need to digest a mountain of negative economic data and possibly many bankruptcies.

The best-case scenario is likely to be a U-shaped recovery and not a V-shaped one. The world post-coronavirus is not going to be the same for a long time to come. Social behaviour needs time to return to normal which means the services sector will continue to feel the pain.

For now, let’s hope that we beat the coronavirus and it becomes just a memory of the past.

 

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