Markets Post Sharp Rally Off Pandemic Lows
Over the past two-plus months, equity markets have rallied sharply, with vast stimulus and optimism surrounding the reopening of the economy as the main drivers. This rebound in equity prices has coincided with ongoing concerns about the health of the global economy.
On June 8th, the S&P 500―at least temporarily―returned to positive territory for calendar year 2020. This coincided with the announcement from the National Bureau of Economic Research that the U.S. had officially entered a recession in February.
From its all-time high on February 19th, the S&P 500 declined 34% through March 23rd. It officially entered bear market territory on March 12th, marking the end of a nearly 11-year old bull market. Markets globally were off sharply during this period.
Off these lows, the subsequent rally for U.S. equities is unprecedented in terms of magnitude in such a short time period. As of the June 8th market close, the S&P 500 had appreciated over 45% since late March and was within 4% of its peak. Dating back over 50 years, the 40% gain for the Index during the first 50 trading days following March 23rd is unmatched. The only other distinct periods when the 50-day returns exceeded 30% began in March 2009 following the lows of the Great Financial Crisis (GFC), which coincided with the start of the most recent bull market, and the rally in October 1982, which was the beginning of a five-year bull market.
In recent weeks, there has been a resurgence in value-oriented stocks. Prospects for these stocks―which, as a group, had already meaningfully lagged growth peers for the three-year period preceding the onset of the pandemic―will likely be determined by how smoothly the reopening goes and the degree to which economic data reverts to pre-pandemic levels.
While the market recovery extends outside the U.S., non-U.S. equities remained in negative territory on the year through June 8th. This widened the spread between domestic and international markets that has persisted over the past decade. The MSCI EAFE Index is up 38% since its March bottom, driven by unprecedented central bank support and signs of improving COVID-19 data and economic recoveries in Europe. The 34% gain for the MSCI Emerging Markets Index has lagged results in developed markets. China was relatively resilient during the sell-off, as it moved quickly to contain COVID-19 infections. Performance has not been as strong outside of Asia, where an insufficient public health response has prolonged the crisis.
The sharp rebound for equities has coincided with ongoing concerns about the health of the economy. The Congressional Budget Office projects the U.S. economy will not recover from the pandemic for a decade. A record decline is projected for second quarter GDP. The downturn for the calendar year is expected to be the largest in over 70 years.
The equity rally has occurred despite limited visibility on corporate earnings. Many companies have opted not to provide quarterly and full-year expectations and guidance due to uncertainty related to the impact of the pandemic. FactSet recently estimated a 43% decline in second quarter earnings for the S&P 500, which would represent the largest year-over-year decline in earnings since the fourth quarter of 2008. The Institutional Brokers’ Estimate System estimates 2020 S&P 500 earnings will decline 23% versus 2019, before rebounding in 2021.
Valuations are elevated, with the forward 12-month price-to-earnings ratio for the S&P 500 at 23x. The expected earnings decline this year is no longer reflected in market returns, while in 2019 the Index was up over 30% and earnings grew only 3%.
Other variables could impact prospects for equities in the near-term. These include a potential second wave of COVID-19 infections, social unrest in the U.S. and globally, the upcoming U.S. presidential election, and the state and federal governments’ responses to the elevated unemployment rate.
Investors have taken solace in the broad range of measures the Federal Reserve has implemented to support the economy and financial markets. In the wake of the Fed’s response, its balance sheet rose from $4 trillion in early March to over $7 trillion.
Extreme market volatility, both on the downside and more recently on the upside, reinforces the meaningful value that may be added through rebalancing.