Navigating the COVID-19 bear market
|Global equity markets have fallen sharply over the past 20 days, declining 27.0% from record levels (or 22.4% in AUD-terms). For Australia, this sharp bear market is now the fourth worst in the past 40 years (Figure 1).
Valuation, using more conservative dividend yield metrics, is attractive in absolute terms, with the yield ranging from 3.0% to 5.1% across major markets and the World at 3.6%. When compared to G7 short rates and bond yields at 0.3% and 0.8% respectively, the yield gap is at record levels.
Liquidity support from central banks, following the lessons of the global financial crisis (GFC), appears on track to match the GFC. Most major central banks have cut rates 25-50bps or added to their asset purchase programs in the past two weeks, and seem poised to do more.
The key issue is the size and duration of the earnings downturn associated with the COVID-19 shock. The examples of China and Korea suggest the economic hit can be confined to 1-2 months. A combination of effective quarantine, monetary and fiscal stimulus, and the windfall US$30/bbl fall in the oil price, should limit second round effects and enable recoveries. We await signs of effective quarantine in Europe and, possibly, the US to allow markets to look through the trough of this shock to the recovery.
As a shock that should be reversible, this event-driven bear market should be shaped by the timing of effective quarantine and counter-stimulus measures.
At a sector level, in the short term, cyclicals remain vulnerable, whether they be transport, retail, industrials, housing-related or energy. Defensives, such as food retailers, telecoms, utilities and health care, should be less affected. That said, as the outlook turns, so this sector view should reverse. It will pay to be nimble.
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