Since hitting lows in mid-March, most stock markets have regained about half of what they lost from their peak in mid-February. That’s led many people to wonder why the markets have come back so far, so fast, given the severity of the economic fallout from the COVID-19 pandemic.
I believe there are three main reasons for the recovery—two that have to do with government responses to the crisis, and one that’s about how markets work.
- The amount of economic stimulus the U.S., Canadian and other governments around the world have provided has been enormous. Emergency fiscal measures add up to 7.4% of GDP in Canada and 9.3% in the U.S and the announcements are still coming. A key aim of these measures is to help companies survive the crisis so they can restart their engines quickly when the lockdowns end. That’s helped buoy investor optimism about a recovery.
- Similarly, central banks have stepped in to not only provide huge amounts of liquidity to stabilize financial markets, but also to support companies. The U.S. Federal Reserve and the Bank of Canada are both buying bonds issued by corporations in their respective bond markets. The need to shore up company finances is certainly there. Canadian companies have issued $53 billion worth of bonds in 2020, up 61% year over year, making it the most active year on record, according to Rob Brown, RBC Dominion Securities’ co-head of debt capital markets in the Globe and Mail. Neither Governments nor corporations like the public perception of bailouts, but with central banks buying corporate debt, that’s effectively what is being accomplished by another name.
- Markets are forward looking. When investors assess companies, they look at the value of their future earnings. Yes, the impact of the coronavirus is terrible and the world economy will take a big hit through the first half of 2020, but as the historic data shows, there will be a recovery. No one knows whether it will take months or years, but when you’re discounting company earnings far into the future, there’s a lot of value for those willing to hold on until the economic recovery has run its course. As governments announce more and more support for companies, the picture looks a whole lot brighter than it did in mid-March.
There is no way to predict whether markets have gotten ahead of themselves or are still not high enough to reflect improved prospects for the economy. We’ll only be able to say that in hindsight. The best route forward is to stick to your investment policy targets, rebalance as necessary and crystalize tax losses where you can.
I’ll be summarizing many of the notions that I’ve written about in the past weeks in a recorded presentation that will come out soon, so stay tuned! I’d appreciate any feedback you have on this piece or any others I publish.